CAREER: Economic Crises and Amplification Mechanisms

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The award funds research in macroeconomics. The overall goal is to understand the role of amplification mechanisms in economic crises. Economists have long thought that economic fluctuations (or more severely, crises) may be the result of 'shocks' (unanticipated events) that affect the economic system. However, in the recent case of the Financial Crisis of 2009 followed by the Great Recession, the initiating shocks seemed small relative to the eventual effect on the economy. Many economists have focused on the idea that the economy contains amplification mechanisms that not only transmit but also magnify shocks. The PI wants to investigate possible mechanisms of this type. He will also develop online mini-courses to educate undergraduates and high school students about the financial crisis. The research promotes the progress of economic science on the effects of financial crises. It will also advance the national prosperity by giving policy makers new ideas and tools in the event of future crises.The PI will first consider the role of the 'liquidity trap' as a macroeconomic amplification mechanism. This includes analyzing the implication of the liquidity trip for ex-ante macroprudential regulation and investigating overinvestment in housing as a potential contributing factor the recent U.S. liquidity trap. The second project considers whether the procyclicality of leverage ratios work as a second amplification mechanism. This part of the research will include both empirical research that will test the predicted relationship between uncertainty and leverage ratios using a unique data set from the foreign exchange market and the development of new economic theory. The third goal is to consider what factors keep insurance from working to keep procyclical leverage out of financial markets. For this goal, the PI will develop new models of frictions that contribute to underinsurance.