Essays on money and financial frictions in finance and macroeconomics

This thesis consists of four essays in the area of macro-finance and international finance in financial economics. The common thread linking the four essays is the interaction between money and endogenous default, as well as the scope for policy to improve social welfare. Chapter 1 introduces the novelty of inside money and banking to a New Keynesian model, with the policy focus on the real and nominal behaviours of the macro-economy. The model shows at the zero lower bound on deposit rates (ZLBD), further policy rate reductions reduce spreads, and thereby reduce bank profitability, deposit creation, and output. Moreover, at the ZLBD, Phillips curves are flatter because credit rationing is both contractionary and inflationary. Finally, alternative policy rules are proposed to alleviate the economic strain at the ZLBD. Chapter 2 develops a two-country general equilibrium model to examine the benefits of the bankruptcy code of a capital markets union - in the absence of a fiscal union - as an alternative mechanism to improve the financial stability and welfare of a currency union. I show when domestic credit risks are present, a lenient union-wide bankruptcy code that allows for default in the cross-border capital markets union removes the pecuniary externality of banking insolvency; therefore, it leads to a Pareto improvement within the currency union. The model provides the welfare and financial stability implications of bankruptcy within a capital markets union in the Eurozone. Chapter 3 develops a dynamic stochastic general equilibrium (DSGE) model featuring deposit issuance via bank credit and endogenous default to study the complex interactions between the real and nominal sectors of the economy, with policy implications provided. Chapter 4 builds a dynamic model with endogenous default and banks’ costly monitoring to assess the Basel III liquidity tool Net Stable Funding Ratio and its effect on bank credit quality and monetary policy transmission.