Zurich Open Repository and Archive University of Zurich Main Library Strickhofstrasse 39 CH-8057 Zurich www.zora.uzh.ch Year: 2014 Financial frictions in macroeconomics: lessons from advanced and emerging market economies Notz, Stefan Posted at the Zurich Open Repository and Archive, University of Zurich ZORA URL: https://doi.org/10.5167/uzh-108739 Dissertation Published Version Originally published at: Notz, Stefan. Financial frictions in macroeconomics: lessons from advanced and emerging market economies. 2014, University of Zurich, Faculty of Economics. Financial Frictions in Macroeconomics: Lessons from Advanced and Emerging Market Economies Dissertation submitted to the Faculty of Economics, Business Administration and Information Technology of the University of Zurich To obtain the degree of Doctor of Philosophy in Economics Presented by Stefan Notz from Germany Approved in February 2014 at the request of Prof. Dr. Mathias Hoffmann Prof. Dr. Ulrich Woitek The Faculty of Economics, Business Administration and Information Technology of the University of Zurich hereby authorizes the printing of this dissertation, without indicating an opinion of the views expressed in the work. Zurich, 12.02.2014 Chairman of the Doctoral Board: Prof. Dr. Josef Zweimuller¨ To my parents Acknowledgements This doctoral dissertation presents the output of research I have conducted while I was enrolled as a Doctoral student at the Graduate School of Economics at the Uni- versity of Zurich. During my time at the University of Zurich, the Swiss National Science Foundation provided me with financial support through the research module “Capital Flows, Asset Prices and Risk Sharing among Heterogeneous Economies”, which was part of the ProDoc “Macroeconomics and Heterogeneity in Human Behaviour”. I would like to thank them for four years of generous funding. I am indebted to my supervisor Professor Mathias Hoffmann. My research projects benefited tremendously from his support, comments and numerous use- ful discussions during the whole time of my PhD studies. His guidance and advice have significantly influenced my thinking and therefore had a huge im- pact on my thesis. I am also grateful to my second supervisor Professor Ulrich Woitek. In particular, I would like to thank him for giving me the opportunity to participate in his summer school “Programming in Matlab” at the University of Salento, once as an attending student and twice as a teaching assistant. The knowledge I have gained in this course helped me considerably to prepare this thesis. I have presented my research at numerous conferences, workshops, and sem- inars. Chapter 2 of my thesis has benefited from comments of seminar parti- cipants at the “SED Annual Meeting” 2012 in Cyprus, the “Annual Congress of the European Economic Association” 2012 in Malaga, the “European Work- shop in Macroeconomis” 2012 at the ONB¨ in Vienna, the “Spring Meeting of Young Economists” 2012 at the ZEW in Mannheim, the “Workshop on Financial Globalisation, Financial Crises and the (Re–)regulation of Banking: Macroeco- i nomic Implications” 2012 at the University of Zurich, the “Zurich Workshop on Economics” 2011 in Lucerne, and the doctoral seminar at the University of Zurich. Chapter 3 has been presented at the “Singapore Economic Review Con- ference” in 2013, the “Sinergia Workshop on the Macroeconomics of Financial Crises” 2013 at the University of Lausanne, the “SSES Annual Congress” 2013 in Neuchatel,ˆ the “FIW-Research Conference on International Economics” 2012 in Vienna, the “Spring Meeting of Young Economists” 2012 at the ZEW in Man- nheim, the “Conference on Theories and Methods in Macroeconomics” 2012 in Nantes, the “Annual Congress of the European Economic Association” 2012 in Malaga, the “Zurich Workshop on Economics” 2011 and 2012 in Lucerne, the “DIW Macroeconometric Workshop” 2011 in Berlin, and at the doctoral sem- inars at the University of Zurich and the University of Konstanz. Finally, I have presented Chapter 4 of my thesis at the “Zurich Workshop on Economics” 2013 in Schaffhausen. I have received a lot of helpful feedback while presenting at these confer- ences. Furthermore, countless discussions with my colleagues have significantly improved the quality of my thesis. I am particularly grateful to Claudia Buch, Fabio Canova, Samuel Cudre,´ Wouter den Haan, Torsten Ehlers, John Geweke, Fa- bio Ghironi, Pierre–Olivier Gourinchas, Sebnem Kalelmi–Ozcan,¨ Catherine´ Koch, Salvador Ortigueira, Alexander Rathke, Peter Rosenkranz, Almuth Scholl, Bent Sørensen, Iryna Shcherbakova–Stewen, Rahel Suter, and Lobsang Tshering for their comments and suggestions. Finally, and most importantly, I would like to thank my family and friends. Writing a PhD thesis comes with much pressure and stress, and requires a great amount of stamina. In my case, I cannot tell in words how much the backing I have received from my family and friends helped me during the last few years. They supported me without question and without condition in everything I have done. Thank you! Zurich, February 2014 ii Contents 1 Introduction 1 2 Macroeconomic Implications of US Banking Liberalisation 9 2.1 Introduction . 9 2.2 Model Environment . 14 2.2.1 Private Households . 16 2.2.2 Firms . 18 2.2.3 Entrepreneurs . 20 2.2.4 Banks . 25 2.2.5 Exogenous Processes . 29 2.2.6 General Equilibrium . 30 2.2.7 Model Solution . 31 2.3 Calibration . 31 2.4 Banking Deregulation . 34 2.4.1 Steady State Effects . 35 2.4.2 Dynamic Analysis . 36 2.4.3 Empirical Evidence . 39 2.5 Empirical Evaluation of the Model . 40 2.5.1 Data Generation . 41 2.5.2 Firm Entry and Size . 41 2.5.3 Business Cycle Volatility . 43 2.5.4 Risk Sharing . 47 2.6 Conclusion . 52 3 Business Cycles in Emerging Markets: the Role of Liability Dollarisation and Valuation Effects 54 3.1 Introduction . 54 3.2 Descriptive Analysis . 59 3.2.1 Business Cycle Features . 59 3.2.2 Valuation Effects . 63 3.3 The Model . 65 3.3.1 Benchmark Model . 66 3.3.2 Liability Dollarisation . 73 3.3.3 Model Solution . 75 3.4 Estimation and Calibration . 76 3.4.1 Data . 77 3.4.2 Calibration . 78 3.4.3 Estimation . 79 iii 3.5 Estimation Results . 82 3.5.1 Parameter Distributions . 82 3.5.2 Model Fit . 85 3.6 Model Analysis . 87 3.6.1 Forecast Error Variance Decomposition . 88 3.6.2 Impulse Response Analysis . 90 3.6.3 Business Cycle Moments . 96 3.6.4 Mexico’s Tequila Crisis . 99 3.7 Conclusion . 101 4 Current Account Dynamics in Emerging Markets: Is the Cycle really the Trend? 103 4.1 Introduction . 103 4.2 Theoretical Model . 107 4.3 Identification Approach . 110 4.3.1 Econometric Model . 110 4.3.2 Identification . 111 4.3.3 Validation of the Identification Scheme . 115 4.4 Empirical Results . 121 4.4.1 Data . 121 4.4.2 Cointegration Tests . 123 4.4.3 Global and Country–Specific Components . 124 4.4.4 Impulse Responses . 129 4.4.5 Explaining Current Account Dynamics . 132 4.4.6 Forecast Error Variance Decomposition . 137 4.5 Conclusion . 140 A Appendix to “Macroeconomic Implications of US Banking Liberalisa- tion” 142 A.1 The Model . 142 A.1.1 Households . 142 A.1.2 Firms . 146 A.1.3 Entrepreneurs . 149 A.1.4 Banks . 153 A.1.5 General Equilibrium . 158 A.1.6 Model Solution . 159 A.2 Steady State . 161 A.2.1 Pre–Deregulation Economy . 161 A.2.2 Post–Deregulation Economy . 166 A.3 State–Specific Calibration . 171 A.4 Banking Deregulation Dates . 174 B Appendix to “Business Cycles in Emerging Markets: the Role of Liability Dollarisation and Valuation Effects” 176 B.1 Model . 176 B.1.1 Model Framework . 176 B.1.2 Detrending the Variables . 178 B.1.3 Maximisation Problem of the Household . 179 iv B.1.4 International Prices and Trade . 183 B.1.5 Current Account and Valuation Effects . 184 B.1.6 Model Summary . 186 B.2 Solving the Model . 191 B.3 Estimation Results . 197 B.3.1 Data for Estimation . 197 B.3.2 Parameter Distributions . 203 B.3.3 Random Walk Component of the Solow Residual . 205 B.4 Forecast Error Variance Decomposition . 208 B.5 Impulse Responses . 213 B.6 Business Cycle Moments . 215 C Appendix to “Current Account Dynamics in Emerging Markets: Is the Cycle really the Trend?” 217 C.1 Stochastic Growth Model . 217 C.1.1 Detrending the Variables . 218 C.1.2 Maximisation Problem of the Representative Household . 219 C.1.3 Steady States . 223 C.1.4 Solving the Model . 223 C.2 Global versus Country–Specific Shocks . 225 C.3 Impulse Responses . 227 C.4 Forecast Error Variance Decomposition . 238 C.5 Estimated Cointegrating Matrix . 240 v List of Figures 2.1 Transition to Full Intra– and Interstate Banking . 11 2.2 Structure of the Model Economy . 15 2.3 Selected Impulse Responses to Banking Deregulation I . 37 2.4 Selected Impulse Responses to Banking Deregulation II . 38 3.1 Business Cycles in Output . 62 3.2 Valuation Effects and the Current Account in Emerging Markets . 64 3.3 Forecast Error Variance Decomposition – Model Comparison . ..