Credit market failure and macroeconomics

Abstract

This thesis aims to contribute to our understanding of the relationship between market failure on capital markets and macroeconomic outcomes in various forms. The notion of credit markets as a frictionsless veil over real economic activity has proven to be unfruitful with respect to many questions of economic interest. To name only a few examples, in the absence of financial frictions there is no difference between internal and externalfinancing, no trade-off between equity and debt, and there is no reason for banks to exist. In order to correctly identify and address the policy needs which might arise from credit market failure, we need to learn more about the fundamental conditions which give rise to the financial contracts and institutions observed in reality. The first chapter of this thesis focuses on the phenomenon of the publicly traded firm with its separation of ownership and control. I show how a time-varying misalignment of incentives of firm managers and investors can have important consequences for aggregate business fluctuations. In particular, a rise in idiosyncratic firm-level uncertainty may result in an economy-wide increase in the default rate on corporate bonds together with a drop in measured firm productivity and output. Bank transparency is the topic of the second chapter. In this model, banks are special because the product they are selling is superior information about investment opportunities. Intransparent balance sheets turn this public good into a marketable private commodity. In the absence of policy intervention, bank competition results in complete bank opacity and a high degree of aggregate uncertainty for households. Mandatory disclosure rules can improve upon the market outcome. The third chapter is joint work with David Strauss. It focuses on the consequences of credit market failure for development and growth. We show that capital market imperfections may give rise to a poverty trap associated with permanent productivity differences across countries. Key to this phenomenon is a sorting reversal in the matching between human capital and heterogeneous production sectors.