Financial Frictions, Fiscal Policy and Business Cycle Dynamics.

This thesis examines the role of financial frictictions, capital regulation and fiscal policy in business cycle dynamics. It consists of three self-contained chapters. In the first chapter I develop a model with financial frictions on the supply and demand side of credit. I introduce a financial accelerator mechanism on the demand side of credit that can be implemented without the costly state verification approach. Moreover, using Bayesian methods I compare three models: a plain vanilla new Keynesian model, a model with banking frictions, and a model with banking and entrepreneurial frictions. I find that (i) there are substantial differences between the model with no financial frictions and the model with the banking sector in explaining non financial data, (ii) the model with the banking and entrepreneurial sector frictions outperforms the model with the banking sector friction in explaining financial data and (iii) the capital quality shock is a key driver of business cycle fluctuations. The second chapter develops an open-economy DSGE model with an optimizing banking sector to assess the role of capital flows, macro-financial linkages, and macroprudential policies in the Philippines. The key result is that macroprudential measures can usefully complement monetary policy. Countercyclical macroprudential polices can help reduce macroeconomic volatility and enhance welfare. The results also demonstrate the importance of capital flows and financial stability business cycle fluctuations as well as for supply side financial accelerator effects in the amplification and propagation of shocks. The last chapter introduces in an otherwise standard real business cycle model a more general and data coherent class of production functions, namely a constant elasticity of substitution production function. I show that the degree of substitutability between production factors is a key ingredient to understand the (de)stabilising properties of a balanced-budget rule. Then I calibrate the model consistently with the empirical evidence, i. e. we set the elasticity of substitution between labour and capital below unity. I show that compared to the Cobb-Douglas case, the likelihood of indeterminacy under a balanced-budget rule is greatly reduced