ESSAYS ON THE REAL EFFECTS OF FINANCIAL FRICTIONS

Abstract

This dissertation explores how different shocks affect real economic outcomes in the presence of financial frictions. The first essay shows that a decline in trade costs facilitated by railroads in the 19th century US increased wealth inequality. Using the universe of household-level wealth holdings data from 1850 to 1870, this essay shows that the increase in county market access facilitated by the expanding railroad network led to an increase in county-level wealth inequality. This essay also studies the effect of financial development on the sensitivity of inequality to trade costs. The level of financial development matters because in areas with higher financial development, relatively poor households can access finance and take advantage of increased economic opportunities provided by lower trade barriers. Consistent with this theory, I find the effect of trade costs on inequality is lower in areas with better developed banking systems. A quantitative model with heterogeneous households, occupational choice, financial frictions, and trade can rationalize these empirical findings.

The second essay explores how credit market competition affects consumer bankruptcies. Prior research has shown that higher competition can induce banks to increase risk-taking activities but most of this work focuses on the implications for the stability of the banking system. This essay estimates the relationship between bank competition and the personal bankruptcy rate using large bank mergers as exogenous shifts in local banking market competition. I also present evidence at the bank level showing that banks that operate in more competitive markets extend more loans and have higher loan losses, consistent with this risk-taking channel.

In the third essay, which is joint work with Palaash Bhargava (Columbia University), we investigate whether temporary positive shocks to banks’ liquidity affect real outcomes. We exploit cross-bank variation in liquidity shocks induced by the 2016 Indian demonetization. We document an increase in investment due to a credit supply effect, primarily driven by small firms. Using matched firm-bank data, we provide evidence that short-term bank credit increased for those firms whose primary bankers experienced a higher deposit shock as a result of demonetization. To isolate the credit supply effect, we exploit the fact that firms use different sources of debt financing.