Title: Three Essays in Macroeconomics
Description: In this dissertation, I examine three questions of relevance to macroeconomists. Chapter 1 investigates how the interconnected production and trade credit networks of firms lead to the propagation of financial shocks. Chapter 2 documents that conditional moments of the price change distribution are extremely informative and yield new insights on the dynamics of price changes in the economy. Chapter 3 offers a detailed investigation of the foreign exchange risk premium through the inflation-indexed bond market structure. In Chapter 1, I study the transmission of firm-level shocks in the economy. Firms are connected through the production network. At the same time, the production linkages coincide with financial linkages because of delays to input payments. Idiosyncratic shocks can spillover in the network through production and financial linkages among firms and generate aggregate economic fluctuations. Chapter 1 investigates how these interconnected production and financial linkages lead to the propagation of financial shocks both upstream and downstream.

First, I show that financial shocks can propagate upstream if there are financial linkages of firms and financial frictions in trade. Second, I find, based on the input-output matrix and the bond yield data in the U.S., upstream propagation of financial shocks is stronger than downstream propagation. Third, I elaborate a DSGE model that can capture this pattern of shocks and generate quantitative predictions. Fourth, I demonstrate that credit policies would have a stronger impact if liquidity were transferred to downstream sectors after aggregate liquidity shocks. The second chapter documents the price setting behaviour of firms. The effectiveness of monetary policy depends both on the presence and the forms of nominal rigidities in price setting. Understanding the dynamics of price changes (when and how price changes) is necessary to determine the true degree of monetary non-neutrality. Chapter 2 shows that conditional moments, which have been seldom used, are extremely informative and yield new insights on the selection effect of price changes.

It documents the predictions of a broad class of existing price setting models on how various statistics of the price change distribution change with the rate of aggregate inflation. Notably, menu cost models uniformly feature the price change distribution becoming less dispersed and less skewed as inflation rises, while in the Calvo model both relations are positive. Using a novel data set, the micro data underlying the U.S. CPI from the late 1970's onwards, Chapter 2 evaluates these predictions using the large variation in inflation over this period. Price change dispersion does indeed fall with inflation, but skewness does not, meaning that none of the existing models can fit these patterns. It then presents a model that does, in addition to matching the price change moments that existing models do. The model features random menu costs. With a menu cost distribution that gives a significant probability to free price changes, and a high probability to very high menu costs, the model predicts a flat inflation-skewness relation.

This menu cost distribution moves the model close to a Calvo model, and the model therefore exhibits a much higher degree of monetary non-neutrality than the Golosov and Lucas (2007) model, and higher even than in the subsequent menu cost models such as Midrigan (2011). Finally, the last chapter investigates an important input in firms' and households' investment decisions process - risk premium of the foreign exchange market. Risk premium in the foreign exchange market has been a prominent research topic in international macroeconomics for decades. For example, it plays an important role in explaining the well-known interest parity puzzle and in investigating the foreign exchange market structure. Chapter 3 offers a detailed investigation of the foreign exchange risk premium using a novel structural relationship in the inflation-index bond market, firstly introduced by Clarida (2012). Unlike the conventional VAR approach, this approach estimates risk premium through the non-arbitrage relationship between investing inflation-indexed bonds from two countries and works on the market information set.

There are two main findings. First, the estimated risk premium is able to forecast subsequent exchange rate changes. Second, contrary to the original finding of Meese and Rogoff (1983) that, even given the ex post realizations of fundamentals, exchange rate changes are difficult to explain, there are in fact periods in which exchange rate movements are driven largely by the fluctuation in the fair value.