| Summary: | <p>The first model of my thesis introduces a monetary Real Business Cycle model with
incomplete markets, a durable good, collateralized securities and endogenous default.
We establish that equilibria are inefficient since agents underinvest due to the existence
of endogenous default. Moreover, the Pareto optimal equilibrium allocation cannot be
achieved through monetary policy. Our analysis suggests the need of an additional
policy tool to generate optimal investment and improve equilibrium allocations. In
the second model of my thesis, we propose an integrated tractable framework that
incorporates endogenous default in a continuous-time setting. Productive experts that
face leverage constraints and aggregate risk, borrow from households and choose to
partially default subject to a penalty that decreases their objective function. Our
results show that default increases borrowing costs, lowers expert’s capital holdings,
suppresses investment and subsequently leading to a recession. We show that the path
of inflation under quantitative easing policies that target interest rates, is determinate
in the presence of default. We achieve this through different payoff profiles that a
collateralised defaultable bond achieves in different states of nature with distinct default
outcomes. In the model, heterogeneous households trade this bond and other shorter
maturity risk-free bonds to maximise their intertemporal utility of consumption and
labour. The differentiated payoffs of the collateralised bond, in an equilibrium with
active default, span the full state space giving determinacy of prices and inflation as an
outcome.</p>
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