| The thesis consists of three essays that examine the role that adverse selection plays in macroeconomics.; The first chapter considers the aggregate implications of adverse selection in financial markets. This chapter addresses three questions. Does the financial system stabilize or destabilize the economy? What are the magnitudes of these effects, and how can one test for such destabilizing effects? I compare a model with adverse selection to the costly state verification framework that is used in most papers in the literature on financial propagation mechanisms. There are specifications of my model in which adverse selection stabilizes the economy. In contrast, the costly state verification mechanism is always destabilizing. At the same time, there are other parameterizations in which adverse selection amplifies shocks to a much greater extent than would the costly state verification mechanism. Although accelerators and stabilizers are observationally equivalent along many dimensions, I present a method that can distinguish between them empirically.; The second chapter presents a discrete adjustment model (sS) of the used car market. In the model, the adjustment costs arise endogenously due to an adverse selection, or “lemons”, problem. Unlike typical sS environments, adjustment triggers in this model contract as the variance of the shock process increases. The chapter goes on to present a dynamic version of the model in which agents are allowed to make decisions that are conditional on the age of a used car. As a car ages, the lemons problem tends to decline in importance, and the sS bands contract.; The last chapter considers how monetary policy should be conducted when loan markets are faced with adverse selection. To answer this question, I construct an overlapping generations model that allows for valued money and an active loan. When loan markets function efficiently, the aggregate supply curve is vertical. However, if these markets are distorted, then the aggregate supply curve may be upward or downward sloping depending on the nature of the market failure. In these cases, the optimal monetary policy must be explicitly cyclical and may involve systematic deviations from Friedman's fixed growth rate rule. |
