The recent financial crisis raises many important issues from a macroeconomic perspective. Standard macroeconomic models are not adequate to address these issues because they typically do not incorporate financial factors. The objective of this project is to understand the macroeconomic dimension of the financial crisis and to introduce financial realities into macroeconomic models.
The teams involved in the project (EPFL, HEID, and UNIL) will focus on different perspectives of the crisis and work with different, but complementary, methodologies. The combination of the various topics will give a rich perspective to the macroeconomics of the financial crisis.
@ EPFL
The EPFL team will focus on the macroeconomic implications of default on mortgages and default by financial institutions. The need to introduce default on mortgages in macroeconomic models comes from the fact that the recent financial crisis has its roots in the increase in mortgage delinquencies caused by the bursting of the U.S. housing bubble. The mortgage crisis amplified into a severe financial crisis due to the failure of several financial institutions and the resulting credit crunch. Standard macroeconomic models do not allow for default and bank failure and therefore cannot capture this amplification mechanism. Macroeconomic models with mortgage and bank default can be used to evaluate policy proposals such as alternative underwater mortgages write down schemes and bank recapitalization programs.
@ UNIL
The UNIL team will focus on the macroeconomic implications of market liquidity. In particular, it will model highly leveraged institutions, which play an important role in providing liquidity to markets and reducing volatility when in good financial shape but do the opposite and drive asset prices down when in bad financial shape. It will also explore the reasons behind the large saving glut in emerging economies that provided ample liquidity to developed economies markets before the crisis. This analysis will shed light on whether and which regulation of highly leveraged institutions is needed.
@ HEID
The HEID team will focus on the implications of the recent financial crisis for international capital flows and the international financial system. It will look at the globalization episode in the late 19th century to better understand the behavior of financial institutions during the crisis and at the effects of securitization on financial flows and international risk sharing. The recent crisis could also lead to changes in the international monetary system by reducing the prominent role of the dollar as reserve currency. The HEID team will assess the prospects for the international role of the dollar by drawing on recent research on its use in trade.