This dissertation studies the implications of frictions in the labor and financial markets for the aggregate economy and the central bank’s policies. In each of the two chapters, I develop a general equilibrium model that provides a theoretical justification for the empirically observed behavior of agents in a particular market. I then study the implications of these mechanisms in a dynamic setting and relate these developments to central bank policies.
The first chapter focuses on the household side of the economy and analyzes the multi-dimensional nature of labor supply decisions, aiming to understand how these decisions matter for monetary policy. In particular, I extend the textbook Dynamic New Keynesian (DNK) model to include home production and labor supply decisions along both extensive and intensive margins. Home production introduces an asymmetric effect of wage changes on the employment rate and average labor hours. As a result, the path of total labor hours over the business cycle becomes ambiguous. When the elasticity of substitution between home and market goods is above a threshold value of 2, the aggregate hours become procyclical. In contrast, the total labor hours are always countercyclical in the textbook model.This discrepancy is important for monetary policy: if the central bank excludes household production from its analysis, it mismeasures the output gap. The resulting welfare loss is substantial and equals 0.013 percent in terms of consumption equivalent.
The second chapter centers around the financial sector and analyzes the interbank lending market through the lens of network theory, intending to evaluate how developments in this market affect the overall economy. More specifically, I examine the implications of changes in the interbank lending network for the aggregate loan rate and lending to the real sector. I show that the aggregate loan rate increases in response to a shock that destroys a large fraction of bank relationships and decreases in response to a shock that destroys a small fraction of bank relationships. Furthermore, I find that the topology of the interbank network matters for these dynamics: the loan rate is less responsive to the network disruptions if the interbank network is incomplete. The amplification and propagation of these network shocks depend on the corridor of the policy rates set by the central bank. In particular, as the difference between the discount window rate and the interest rate on excess reserves decreases, the effect of a network disruption on loan rates becomes less significant but more persistent, which in turn leads to a smaller but more prolonged effect on the real sector.