Three Essays on Real-Financial Linkage in Dynamic Stochastic General Equilibrium Models

In this thesis, I contribute to the growing literature on the linkage between real and financial sectors, and study how financial frictions affect responses of important economic variables to different shocks in a New-Keynesian dynamic stochastic general equilibrium (DSGE) framework.The first chapter of this thesis shows that financial frictions can mitigate an important puzzle in the literature related to investment-specific technology shocks.Evidence from estimated DSGE models and SVAR analysis suggests that investment shocks are an important source of business cycle fluctuation in the post-war U.S. economy.In most models that include investment shocks, consumption falls on impact, contradicting its observed comovement with investment, hours worked and output over the business cycle.This chapter shows that introducing financial frictions alongside endogenous capacity utilization in a New-Keynesian model can produce a positive consumption response to an investment shock.By attenuating the response of investment, the financial accelerator mechanism suppresses households' intertemporal substitution towards savings and allows consumption to rise.Search frictions in the labour market introduce a wedge between marginal product of labour and wages determined through Nash bargaining and magnify the positive consumption response.The second chapter of this thesis documents a new challenge for a class of models with binding borrowing constraints related to government spending shocks.We highlight that DSGE models with housing and collateralized borrowing predict a fall in ii both house prices and consumption following positive government spending shocks.The quasi-constant shadow value of lenders' housing and the negative wealth effect of future tax increases on their consumption are the key reasons for this result.By contrast, we show house prices and consumption in the U.S. rise after identified positive government spending shocks, using a structural vector autoregression methodology and accounting for anticipated effects.The counterfactual joint response of house prices and consumption poses a new challenge when using this class of models to address policy issues for the housing market which have come to fore due to the weak recovery after the 2008 financial crisis.The final chapter of this thesis develops a search-theoretic banking model in a New Keynesian DSGE framework that can simultaneously explain cyclical movements in interest spreads and flows in gross loan creation and destruction, that were recently emphasized in the literature.The model features endogenous match separation, and allows bank loans for productive capital purchases to vary in both intensive and extensive margins.Search frictions in the banking sector generates a counter-cyclical interest spread that amplifies business-cycles.In addition, the model generates responses in gross loan destruction and net loan flows to a credit supply shock that can qualitatively match empirical responses estimated in a vector auto-regression framework.iii To my daughters,

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