Semester

Summer

Date of Graduation

2009

Document Type

Dissertation

Degree Type

PhD

College

Chambers College of Business and Economics

Department

Economics

Committee Chair

Arabinda Basistha

Abstract

This dissertation highlights the effects of monetary and fiscal policy on financial markets both within and across borders. In the first essay I examine how credit affects both real GDP and inflation in the U.S. Without a well-functioning credit market, at least two principal components of GDP---consumer durables and investment---would suffer. Credit markets allow individuals and firms to match those with extra savings and those with more pressing spending and investing needs to mutually benefit each other. However, credit markets are diverse. Clearly, some credit variables would be expected to play a more important role in the macroeconomy than others. This paper examines the relationship between credit and the macroeconomy, specifically real GDP and inflation. I find that credit matters. Credit shocks affect real GDP and to a lesser extent inflation, but, not all credit measures do so. Real GDP reacts strongly to changes in credit-to-income ratios and certain interest rate spreads. Inflation, however, responds less so to credit shocks. That is not to say that credit shocks are not important for inflation. Particularly, certain credit aggregates and interest rate spreads that measure short-term and long-term rates appear to be influential for changes in inflation. In the second essay I use a dynamic panel data set to examine the effect of fiscal policy on real interest rates for a sample of 59 nations covering the time period from 1970 through 2006. Controlling for both country and time effects, I find that changes in the national budget affect real interest rates. A one-percent increase in a country's deficit-to-output ratio corresponds to an increase in that country's real interest rate. This increase is statistically and economically significant; it ranges in magnitude from approximately 12 to 15 basis points. A surprising secondary result also emerges: a country's financial openness does not appear to play an important role in the determination of their real interest rate. Finally, the third essay illustrates how the Mexican equity market reacts to US monetary policy surprises. In this essay I also document whether the Mexican equity market reaction is asymmetric. I use a popular measure for US monetary surprises and I control for comovements in the US and Mexican equity markets. I find that when cyclical variations are measured according to real GDP growth, the Mexican equity market responds more to US monetary policy shocks when the Mexican economy is experiencing a downturn. This is important as it shows that the credit channel works across international borders.

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