| This dissertation explores financial instability from a macroeconomic and institutional perspective. The framework, common to all chapters, brings financial instability within the purview of macroeconomics, by (1) fully integrating payments and banking, (2) allowing for wide-spread default among leveraged borrowers following an asset price decline, and (3) doing so in a tractable analytical model without resorting to linearization, despite dynamic general equilibrium.; Chapter one proposes a macroeconomic model of banking distress. We analyze how wide-spread default affects the banking system, and how the state of the banking system in turn affects the economy. The interaction of credit, asset prices, and loan losses generates a complete spectrum of outcomes, including credit crunches, financial instability, and banking crises, for which separate, microeconomic theories had been devised. Self-fulfilling equilibria are possible if the banking system reacts to loan losses by contracting credit. The model puts in perspective central banking concerns such as the role of asset prices in monetary policy, and the procyclical effect of capital requirements. The model is also applied to Japan's Lost Decade and the US Great Depression.; Chapter two proposes a model of debt-deflation. We analyze how agents adjust their asset positions in response to unanticipated losses. Distress selling, intended for repaying debt, reduces inside money, asset prices and the price level, giving rise to the channels of debt-deflation described by Fisher, Minsky, Tobin, and Bernanke. Yet the economy remains surprisingly resilient even with wide-spread distress selling and default. Debt-deflation becomes unstable once banks reduce credit, or once agents choose, or margin requirements force them, to contain their indebtedness.; Chapter three shifts focus from solvency to liquidity. We analyze the mechanics of liquidity provision to a declining asset market. For dealers to provide liquidity, they rely on bank loans, and for banks to lend, they rely on central bank liquidity provision. System properties are used to identify which banks, and which methods of clearing and settlement, are best suited for providing liquidity. Liquidity is perfect, as assumed in finance theory, only if dealers are in perfect competition and the central bank supports orderly clearing and settlement. |
