Essays on macro financial linkages

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The first chapter, joint with Dominik Thaler, is a New Keynesian model of how monetary policy can influence the risk-taking behaviour of banks. Lower interest rates change bank incentives, making them prefer riskier investments. This mechanism alters the tradeoff faced by the monetary authority, affecting optimal policy conduct. After estimating the model, we find that the monetary authority should react less aggressively to inflation, trading off more inflation volatility in exchange for less financial market distortions. The second chapter, written with Prof. Massimiliano Marcellino, investigates whether modelling parameter time variation and stochastic volatility improves the forecasts of three major exchange rates vis-a-vis the US dollar. We find that modelling time-varying volatility significantly refines the estimation of forecast uncertainty through an accurate calibration of the entire forecast distribution at all forecast horizons. Similar empirical tools are employed in the third chapter, where I show that the inclusion of default risk and risk aversion measures improves the forecasts of key activity and banking indicators. The bulk of forecast improvement takes place during the 2001 and 2008 recessions, when credit constraints were arguably binding. A structural VAR further reveals that an unexpected credit spread increase in 2010 causes an output contraction that lasts for about two years, and explains up to 35% percent of output variation. The final project, joint with Sandra Eickmeier, Prof. Massimiliano Marcellino and Wolfgang Lemke, investigates the changing international transmission of financial shocks over 1971-2012. A time-varying parameter FAVAR shows that global financial shocks, measured as unexpected changes in a US financial condition index, strongly impact growth in the nine countries considered. In addition, financial shocks in 2008 explain approximately 20% of the GDP growth variation in the 9 countries, as opposed to an average of 5% percent before the crisis.