UC San Diego

This dissertation consists of four chapters, each of which studies monetary policy, financial stability, or their interaction.

Chapter one shows empirically that, contrary to theoretical claims, raising interest rates increases bank leverage. I propose and empirically validate the loan-loss mechanism to explain this result: contractionary shocks increase loan losses, reduce bank profits and equity, and ultimately increase bank leverage. I develop a banking model where floating-rate loans entail a trade-off between interest rate risk and credit risk, which generates the loan-loss mechanism. Using microdata, I provide empirical evidence consistent with floating-rate loans hedging interest rate risk at the expense of generating loan losses.

Chapter two examines the effects of central bank meetings on stock returns. Cieslak et al. (2019) show that stock returns in the US and internationally are driven by even-week meetings of the Federal Open Market Committee. I find that the US result and the proposed mechanism do not hold out-of-sample, losing robustness as early as 2004. Prior to 2004, there appear to be outliers driving the result. Finally, I show that the international result does not apply in either the UK or Japan.

Chapter three studies the consequences of including financial stability among the central bank's objectives when market players are strategic. Our model predicts that central banks underreact to economic shocks, a prediction consistent with the Federal Reserve’s behaviour during the 2023 banking crisis. Policymakers’ stability concerns bias investors' choices, inducing inefficiency. If central banks have private information about their policy intentions, the equilibrium forward guidance is vague because fully informative communication is not credible. A "kitish" central banker, who is less concerned about stability, reduces these inefficiencies.

Chapter four studies how financial and production networks affect the transmission of financial shocks to the real economy. We propose a general equilibrium model of production networks featuring heterogeneous banks and endogenous firm-bank linkages. We theoretically characterise the aggregate effects of bank-specific shocks in terms of a number of sufficient statistics. We suggest an approach to empirically complement our theoretical framework which relies on misconduct provisions of UK banks combined with detailed firm-bank-loan data to construct instruments for firms’ credit supply.