Essays on Macroeconomics

Abstract

This thesis studies the effect of domestic bank run risks on government borrow- ing and reserve policies in models that feature systemic bank runs and sovereign default. In chapter 1, I develop a qualitative analysis of financial instability and government interventions to study the effectiveness of government’s bailout policies in stabilizing the banking system and improving economic outcomes during periods of limited fiscal capacity. The central result from this analysis is that an ex-post lender-of-last-resort policy is effective only if the government is fiscally credible, and that a reserve position augments the fiscal resources and allows the government to eliminate banking panics and implement the no-run competitive equilibrium outcome. In chapter 2, I propose a quantitative model of systemic bank runs and sovereign default to study welfare implications of reserve accumulation and bank transfer policies when the fiscal sustainability risk and bank run risk are taken into consideration. Policymakers in developing countries often argue that an important reason for having international reserves is to have adequate liquidity in the event of shocks like bank runs. When countries’ fundamentals are weak, pessimistic expectations of investors can lead to runs on the domestic banking system. A government which commits to aggressively intervene ex-post can help to eliminate the ”pessimistic” run equilibrium. Such intervention, by simply borrowing in the face of an impending crisis, is costly because interest rates rise sharply in crisis times. One way to prepare for crises is to build up a stock of international reserves in normal times. The model connects the roles of reserves with private economic activity via the government’s financing need for discretionary expenditures that stems from promised bailouts of the banking system in crisis times. In the quantitative exercise, I find that a procyclical reserves accumulation-decumulation policy equal 2.5% of output, when coupled with a modest bank transfer policy, delivers a welfare gain of 0.018% in consumption equivalence term.