Policy distortions and financial frictions are two leading candidates in generating capital misallocation. This paper designs an identification strategy to separate their effects on average MRPK dispersion across firm ownership, as the average treatment effect on the treated and the selection bias from a policy intervention. Financial frictions are estimated to cause an aggregate TFP loss of 8....

Abstract Recessions that are accompanied by financial crises tend to be more severe and are followed by slower recoveries than ordinary recessions. This paper introduces a new Keynesian model with financial frictions on both the demand and supply side of the credit markets that can explain this empirical finding. Following a shock that leads to a decline in economic activity, an adverse feedbac...

Balance-sheet variables of firms have been characterized by greater volatility since the early 1970s. This Financial Immoderation has coexisted with the so-called Great Moderation, which refers to the slowdown in volatility of real and nominal variables since the mid 1980s. In this paper, we examine the divergent patterns in volatility by considering the role played by financial factors. To do ...

In models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We develop a two-sector new-Keynesian model to evaluate different inflation targeting rules in economies with financial frictions. We conclude that, in the presence of financial frictions, a welfaremaximizing central bank should adopt flexible head...

In this paper, I argue that the operation of the formal financial system is profoundly important for the poor. It influences how many people are hungry, homeless and in pain. It shapes the gap between the rich and the poor. It arbitrates who can start a business and who cannot, who can pay for education and who cannot, who can attempt to realize one’s dreams and who cannot. Finance affects the ...

To understand the link between financial intermediation activities and the real economy, we put forward a general equilibrium model where agency frictions in the financial sector affect the efficiency of capital reallocation across firms and generate aggregate economic fluctuations. We develop a recursive policy iteration approach to fully characterize the nonlinear equilibrium dynamics and the...

This paper presents a quantitative model of economic transitions. We explicitly model resource misallocation and financial frictions to explain observed transitional dynamics that are not consistent with the standard neoclassical growth theory. When calibrated to empirical evidence on resource misallocation and financial frictions in less developed countries, our model economy converges slowly ...

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the author. No responsibility for them should be attributed to the Bank of Canada. Abstract This paper builds a two-country DSGE model to study the quantitative impact of financial frictions on business cycle co-movements when investor...

In this paper we present a political economy approach in order to explain the degree of financial openness for an economy. In the model, entrepreneurs, who may have good or bad projects, vote for policies, which are proposed by selfish politicians. Two political frictions (ideological adherence and a supermajority requirement) impair political competition and lead to equilibria, where politicia...

This paper analyzes—both empirically and theoretically—how fluctuations in uncertainty interact with financial market imperfections in determining economic outcomes. In a standard bond-contracting framework, an increase in uncertainty benefits equity holders at the expense of bondholders, and to the extent that firms face significant frictions in financial markets, increased uncertainty implies...