Why in market economies is it the owners of capital that almost always hire labor? Classical general equilibrium theory is silent on this question: whoever controls a firm whether it be the owners of capital or the owners of labor, or someone else, simply picks the value maximizing point in that firm's production possibility set. In market economies we typically see limited liability of the owners of firms. We also see bankruptcies and often firms are reorganized and control is transferred to new owners and sometimes firms are liquidated. This project develops a model in which bankruptcy, reorganization, and liquidation occur in equilibrium and in which it is optimal for capitalists to own and control the firm. Currently quantitative general equilibrium models of the business cycle abstract from financial intermediation. One widely held view of the business cycle is that shocks to the economy which do not directly have a large effect on aggregate production possibilities may end up having large aggregate consequences due to interactions with the financial intermediation system. For example, the financial crises of the late 19th and early 20th centuries were followed by severe declines in output and employment which seem far too large to be accounted for by technology shocks. The contribution of this project comes from the development of the first quantitative general equilibrium model of the business cycle in which financial intermediation plays a central role. These models are used to reassess the effects of monetary and fiscal policy, including various regulations and policies with regard to financial intermediation. An extended version of the model explores financial crises over the cycle. The third part of this project evaluates monetary and fiscal policy with limited contracting among agents. A quantitative model with nominal wage contracts is developed and its policy implications are explored. A model is also developed in which income distribution interacts with the tax system. These models are used to quantitatively study the interact ion between equity and efficiency goals in the design of tax policies.
