Financial Frictions, Propagation of Shocks, and Macroeconomic Volatility

I study the evolution of aggregate volatility in the US during the postwar period by assessing the relative role played by financial shocks, technological progress, and changes in the financial system. 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 the second chapter, I study the moderation in real variables calibrating a real business cycle model with two technology shocks. I consider several statistical specifications for technological progress. A deterministic trend model outperforms in accounting for volatilities, but a stochastic trend model accounts better for the correlation structure of the data. In the third chapter, I account for the divergent patterns in volatility analyzing the role played by financial factors. To do so, I estimate a DSGE model including financial rigidities, allowing for structural breaks in a subset of parameters. I conclude that the Financial Immoderation is driven by larger financial shocks and that the estimated reduction in the size of the financial accelerator in the mid 1980s accounts for 30% of the decline in the volatilities of investment growth and the nominal interest rate. In the last chapter, I focus on analyzing financial shocks. Using the estimation output, I obtain that the contribution of financial shocks to the variance of investment is increasing over time, reducing the relative importance of the investment-specific technology shock. The estimated reduction in the level of financial rigidities has a signifficant impact on the model implied propagation dynamics. Given that the model implies a negative response upon impact of consumption in response to a positive business wealth shock, I empirically characterize the effects of such a financial shock on consumption using sign restrictions. I conclude that documenting the effects on consumption is not a trivial matter since the results vary signifficantly depending on the variables used to measure business wealth and the cost of external borrowing.