Financial Intermediation, Crises and Aggregate Economic Activity

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AbstractProposal Title: Financial Intermediation, Crises and Aggregate Economic ActivityProposal Number: SES - 1325679Principal Investigator: Kiyotaki, Nobuhiro This project studies the interaction between liquidity, asset price and aggregate economic activity. The particular focus is on financial intermediation, crises and real economy. The project examines a set of policy relevant questions such as (1) what causes a financial crisis? Is a crisis caused by misallocation of resources or by bank run? (2) What are the sources of financial instability? Has it to do with contractual incompleteness, or to do with the limited participation of small businesses and households in asset markets? (3) How should government intervene? How and when should monetary and fiscal policies ameliorate financial crises? (4) Why do certain countries (such as Japan and some European countries) experience a long stagnation after a financial crisis? How could they avoid such a trap? This project would lead to a better understanding of the interaction between financial intermediation, balance sheet adjustment and aggregate production before, during, and after, a financial crisis. By developing a model that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability, the model could improve forecasting financial crisis, as well as pointing out its limitation. The analysis of balance sheet adjustment includes both financial and real assets (such as tangible and intangible capital), providing an insight into how a financial crisis may lead to a slower growth. This project develops frameworks which would be useful for public policy making. The results of the project would recommend policy makers to take an eclectic approach to the financial instability.