'An analysis of the interrelationship between credit market dynamics and macroeconomic fluctuations'

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This research proposal seeks to answer 4 research questions. The first question is whether fluctuations inthe price and quantity of credit are supply driven or demand driven. The view that shocks to credit supplyare an important factor driving macroeconomic fluctuations became a prevalent view following the crisis of2007/8 and informed much of the subsequent policy response. However, the view that fluctuations in theprice and quantity of credit are primarily supply driven is contested. The second question is whether thefinancial sector as a whole seeks to maximise leverage. The view that financial institutions seek tomaximise leverage subject to a Value-at-Risk constraint (i.e. subject to a maximum potential loss at agiven probability level) has become a prominent way to model credit supply shocks. However, evidencethat the financial sector as a whole behaves in this way is not clear-cut. The third question is howincorporating uncertainty into Value-at-Risk models may affect financial sector behaviour. The distinctionbetween risk (where the distribution of possible outcomes is known) and uncertainty (where thedistribution is not known) may provide additional insight with which to characterise financial sectorbehaviour. The fourth question is what are the implications of incorporating insurance into value-at-riskmodels. This insurance may either take the form of explicit counterparty insurance (e.g. credit defaultswaps) of the form of implicit state backing (e.g. 'too big to fail'). It is hoped that the answers to theseresearch questions will provide useful insights for macroprudential and monetary policy.