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Essays on Economic Volatility and Financial Frictions

  • Author(s): Zhao, Hongyan
  • Advisor(s): Gorodnichenko, Yuriy
  • et al.
Abstract

This dissertation consists of three essays in macroeconomics. The first one essay discusses the reasons of Chinese huge foreign reserves holdings. It contributes to the literature of sudden stops, precautionary saving and foreign assets holdings. In the second essay, I study the price volatility of commodities and manufactured goods. I measure the price volatility of each individual goods but not on the aggregated level and therefore the results complete the related study. The third essay explores the correlation between the relative volatility of output to money stock and financial development. It extends the application of financial accelerator model.

In the first essay, I address the question of China's extraordinary economic growth during the last decade and huge magnitude of foreign reserves holdings. The coexistence of fast economic growth and net capital outflow presents a puzzle to the conventional wisdom that developing countries should borrow from abroad. This paper develops a two-sector DSGE model to quantify the contribution of precautionary saving motivation against economic sudden stops. The risk of sudden stops comes from the lagged financial reforms in China, in which banks continue to support inefficient state-owned enterprises, while the more productive private firms are subject to strong discrimination in credit market, and face the endogenous collateral constraints. When the private sector is small, the impact on aggregate output of binding credit constraints is limited. However, as the output share of private sector increases, the negative effect of financial frictions on private firms grows, and it is more likely to trigger a nation-wide economic sudden stop. Thus, the precautionary savings rise and the demand for foreign assets also increases. Our calibration exercise based on Chinese macro data shows that 25 percent of foreign reserves can be accounted for by the rising probability of sudden stops.

The second essay studies the relative volatility of commodity prices with a large dataset of monthly prices observed in international trade data from the United States over the period 2002 to 2011. The conventional wisdom in academia and policy circles is that primary commodity prices are more volatile than those of manufactured products, although most existing studies do not measure the relative volatility of prices of individual goods or commodities. The literature tends to focus on trends in the evolution and volatility of ratios of price indexes composed of multiple commodities and products. This approach can be misleading. The evidence presented here suggests that, on average, prices of individual primary commodities are less volatile than those of individual manufactured goods. Furthermore, robustness tests suggest that these results are not likely to be due to alternative product classification choices, differences in product exit rates, measurement errors in the trade data, or the level of aggregation of the trade data. Hence the explanation must be found in the realm of economics, rather than measurement. However, the challenges of managing terms of trade volatility in developing countries with concentrated export baskets remain.

The third essay tries to understand why the relative volatility of nominal output to money stock is negatively related to countries' financial development level from cross-country evidence. In the paper I modify Bernanke et al. (1999)'s financial accelerator model by introducing the classic money demand function. The calibration to US data shows that the model is able to replicate this empirical pattern quite well. Given the same monetary shocks, countries with poorer financial system have larger output volatility due to the stronger effect of financial accelerator mechanism.

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