Essays on macroeconomics and finance

This dissertation consists of three essays that examine the role of institutional frictions and belief formation in understanding financial and macroeconomic puzzles. In two chapters, I study on the transmission channels by which institutional frictions impact aggregate business cycles. In another chapter I explore the link between belief formation and aggregate asset price dynamics. In the first chapter, I study the macroeconomic effects of a 1982 SEC rule that made share buybacks a viable alternative to dividends for paying out funds to shareholders. I propose a quantitative model of heterogeneous firms with dividend adjustment costs and a manager-shareholder conflict, matched to micro data on US corporations' cash flow statements. The flexibility of buybacks improves welfare by reducing the misallocation of capital. This is not only because investors can more easily shift resources to more productive firms, but also because stock prices become more responsive to productivity and thus help align incentives of managers and shareholders. This "stock price effect" allows the model to not only account for a decline in investment and increase in productivity, but also the increase in corporate cash holdings over the last decades. In the second chapter, co-authored with Sean Myers, we study how shareholder beliefs and firm payout decisions affect aggregate asset prices. Using survey forecasts, we find that cash flow growth expectations explain most movements in the S\& P 500 price-dividend and price-earnings ratios, accounting for at least 93\% and 63\% of their variation. These expectations comove strongly with price ratios, even when price ratios do not predict future cash flow growth. In comparison, return expectations have low volatility and small comovement with price ratios. Short-term, rather than long-term, expectations account for most price ratio variation. We propose an asset pricing model with beliefs about earnings growth reversal that accurately replicates these cash flow growth expectations and dynamics. In the third chapter, co-authored with Stephen McKnight, we study how institutional frictions in developing economies impact business cycles. This chapter investigates the role of labor informality in the propagation of transitory shocks and its implications for interest rate policy in preventing self-fulfilling inflation expectations. We develop a dynamic New Keynesian model where the size of the informal sector reacts to search and matching frictions in the formal sector, which can account for the observed behavior of formal and informal employment in Mexico. We show that informality reduces the volatility of aggregate consumption and employment, but investment volatility increases. While informality amplifies the propagation of demand shocks on inflation, it dampens the response of output, weakening the transmission mechanism of monetary policy to output. For interest-rate feedback rules that react to formal measures of inflation, we find that informality significantly restricts the ability of the Taylor principle to ensure determinacy. However, we show that determinacy can be restored when policy also responds to formal output

Keywords: economics) degree supervisor.
Economics.
Advisor: Piazzesi Monika
Lustig Hanno