UC Davis

The financial sector influences the macroeconomy in many aspects. Monetary policy affects firms' external financing and investment decisions through its impact on credit costs in financial markets. Institutional reform in financial markets can affect this monetary policy transmission. Safe assets are an important part of an economy. They are demanded by agents who look for a safe store of value, and how safe they are and how large their supply is affect the liquidity property of those assets and welfare of the economy. Financial crises, like the Great Recession, are not only costly in terms of output and investment in the short run, but they also cause productivity slowdown in the longer horizon through their impact on research and development (R&D). This dissertation contributes to the understanding of these issues.

Chapter One studies how monetary policy affects credit costs in financial markets and firms' external financing decisions. I study this transmission mechanism of monetary policy in a general equilibrium macroeconomic model where firms issue corporate bonds or obtain bank loans, and corporate bonds are not just stores of value but also serve a liquidity role. The model shows that an increase in the nominal policy rate can lower the borrowing cost in the corporate bond market, while increasing that in the bank loan market, and I provide empirical evidence that supports this result. The model also predicts that a higher nominal policy rate induces firms to substitute corporate bonds for bank loans, which is supported by the existing empirical evidence. In the model, the Friedman rule is suboptimal so that keeping the cost of holding liquidity at a positive level is socially optimal. The optimal policy rate is an increasing function of the degree of corporate bond liquidity.

Chapter Two, joint work with Athanasios Geromichalos and Lucas Herrenbrueck, studies the relationship between an asset's safety and liquidity. Recently, a lot of attention has been paid to the role "safe and liquid assets" play in the macroeconomy. Many economists take as given that safer assets will also be more liquid, and some go a step further by practically using the two terms as synonyms. However, they are not synonyms: safety refers to the probability that the (issuer of the) asset will pay the promised cash flow, and liquidity refers to the ease with which an asset can be sold if needed. Mixing up these terms can lead to confusion and wrong policy recommendations. In this chapter, we build a multi-asset model in which an asset's safety and liquidity are well-defined and distinct from one another, and examine the relationship between an asset's safety and liquidity in general equilibrium. We show that the commonly held belief that "safety implies liquidity" is generally justified, but there may be exceptions. We then describe the conditions under which a relatively riskier asset can be more liquid than its safe(r) counterparts. Finally, we use our model to rationalize the puzzling observation that AAA corporate bonds are considered less liquid than (the riskier) AA corporate bonds.

Chapter Three studies how financial crises affect R&D activities, which is one of the key determinants of productivity. Recent literature documents the slow recovery and the productivity slowdown in the aftermath of financial crises. Several theoretical papers propose models to rationalize this. Some attribute it to a decline in the level of R&D, while others to a decline in the effectiveness of R&D. Which channel is more empirically relevant is an important question in guiding theoretical works. This chapter contributes to the literature by answering this question. Using data on 30 OECD countries over the years 1981-2016, I estimate the responses of R&D upon recessions and financial crises, using local projections. While recessions are bad times for output and investment in general, most of the responses are coming from the non-R&D part of investment. R&D is overall unresponsive to recessions, even to financial crises. This result suggests that a decline in R&D efficiency is a more empirically relevant channel to the productivity slowdown.