The three chapters of this dissertation examine the role of credit and the policy to control it in macroeconomy. The first chapter analyzes the interactions of macroprudential policy and monetary policy in a New Keynesian DSGE model with financial frictions. Macroprudential policy can stabilize credit cycles. Within this model, welfare-maximizing monetary policy aims to stabilize only inflation and macroprudential policy only stabilizes credit. Credit stabilization is welfare improving because lower volatility is compensated by higher mean equilibrium credit and capital. The second chapter examines the dichotomy between macroprudential policy and monetary policy discussed in the first chapter, in a simple New Keynesian model with credit. In this model, macroprudential policy is effective in stabilizing credit but has a limited effect on inflation. Monetary policy with an interest rate rule stabilizes inflation, but this rule is 'too blunt' an instrument to stabilize credit. This dichotomy between macroprudential policy and monetary policy arises because each policy is designed to differently affect the saving and borrowing decisions of households. In the third chapter, which is a joint work with Todd Walker, we integrate financial market frictions into well-known dynamic, stochastic, general equilibrium models of the macroeconomy in order to assess the ability of these frictions to explain the recent financial crisis and great recession. Specifically, financial frictions are assumed in the entrepreneurial sector, household sector and banking sector. Results suggest that these frictions are not able to explain the Great Recession. These results have significant implications for efficacy of these models as instruments of policy analysis.
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