Essays on Income Inequality, the Banking System’s effect on Economic Stability and on International Capital Flows

In the first chapter I address a contention regarding income inequality between capital and labor. The contention is between Karabarbounis and Neiman (2014) and Elsby et. al (2013) and it focuses on the case of capital deepening when the labor share of income declines and the elasticity of substitution is above unity. I demonstrate the incentive for technicalchange, which increases inequality and how investments in new technology create temporal misalignment between a decrease in the labor share of income and capital deepening. I show how the decline in the saving rate that occurred during the 80’s and 90’s resolves the contention regarding capital deepening. I also find that elasticity of substitution below unity is less consistent with the decline in the labor share of income. A second contention is whether the elasticity of substitution is above or below unity. I perform a time-varying state-space estimation of the evolution of elasticity using the unadjusted marginal product of labor and the Kalman Filter. I find that the elasticity between capital and labor has been fluctuating slightly above unity since 1980, consistent with my theoretical findings leading to conclusion that a Cobb-Douglass production function is a good approximation for the U.S. economy. In the second chapter, I ask what are the dynamics and effects of fractional-reserve bank credit on the real economy. Does fractional-reserve bank credit increase the susceptibility of the economy to financial crises? I introduce a simple general equilibrium model in the tradition of the “debt-deflation” literature that relaxes a no-credit requirement and allows savings and capital to emerge from the micro-foundations of the model, using bank credit to bridge the gap between them. I find that the Real Multiplier, which I use to model the effects of fractional-reserve, amplifies both financial and productivity shocks. Asset prices in the model respond strongly to productivity shocks but much less so to financial shocks. I find that long term monetary stimuli that reduce real interest rate may lead to immediate output increases but at a cost of stagnation and even negative growth. I hypothesize that incorporating a growth objective in monetary policy considerations along with the effects of policy on the steady-state of the economy, may assist in preventing stimuli induced stagnations. In the third chapter, I present a model that provides a theoretical solution to the Lucas Puzzle using Financial Efficiency, which is a time-varying component of TFP. The model predicts that a financially underdeveloped economy is to benefit from financial integration through FDI capital inflow only if it experiences faster technological growth, or faster Financial Development than the developed economy. Fitting the model to the data of India, I find that a sharp increase in India’s Financial Efficiency since 1990 provides a test for the theoretical prediction above and its congruence with the empirical part of the model. Increases in India’s capital per worker and Foreign Direct Investment capital inflow during the same period serve as external validation of the model