Three Essays on Macroeconomic and Financial Stability

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Li, Mei
macroeconomic and financial stability , global games
This thesis studies several issues in the field of macroeconomic and financial stability. In Chapter 2, I argue that systemic bankruptcy of firms can originate from coordination failure in an economy with investment complementarities. I demonstrate that in such an economy, a very small uncertainty about economic fundamentals can be magnified through the uncertainty about the investment decisions of other firms and can lead to coordination failure, which may be manifested as systemic bankruptcy. Moreover, my model reveals that systemic bankruptcy tends to arise when economic fundamentals are in the middle range where coordination matters. High financial leverage of firms greatly increases the severity of systemic bankruptcy. Optimistic beliefs of firms and banks can alleviate coordination failure, but can also increase the severity of systemic bankruptcy once it happens. Chapter 3 studies how coordination failure in a country's new technology investment dampens a country's economic growth. I establish a two-sector Overlapping Generation model where capital goods are produced by two different technologies. The first is a conventional technology with constant returns. The second is a new technology exhibiting increasing returns to scale due to technological externalities, about whose returns economic agents have only incomplete information. My model reveals that coordination failure in new technology investment can lead to slower economic growth. More interestingly, the model generates a positive correlation between economic growth and volatility. In Chapter 4, Frank Milne and I establish a dynamic currency attack model in the presence of a large player. In an attack on a fixed exchange rate regime with a gradually overvalued currency, both the inability of speculators to synchronize their attack and their incentive to time the collapse of the regime lead to the persistent overvaluation of the currency. We find that the presence of a large player can accelerate or delay the collapse of the regime, depending on his incentives to preempt other speculators or to “ride the overvaluation."
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