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New issues in the Analysis of Business Cycles

Periodic Reporting for period 2 - NEW_ABC (New issues in the Analysis of Business Cycles)

Reporting period: 2020-02-01 to 2021-07-31

The last decade had seen an increasing recognition that financial markets play a key role over the business cycle. Still, there have not been many detailed, systematic, empirical investigations on the distributional impact across society on consumption, employment and investment of the interaction between macroeconomic policies and the evolving structure of credit markets. The research agenda developed with the ERC support has developed insights from disaggregated data sets on mortgage originations, the supply of household financial products and firms’ debt originations, and has integrated these insights in theoretical frameworks that introduce credit supply and demand heterogeneity in the analyses of consumption and investment decisions.

Three features of this approach make it of potentially important for society. On the empirical side, the analysis of existing and novel detailed households’, firms’ and lenders’ data sets has allowed us to identify new stylized facts on the transmission of monetary policy to real activity through financial markets (and leverage and asset prices in particular). On the theoretical side, these stylized facts have been used to develop and discriminate among competing channels of macroeconomic policy transmission. Finally, the regularity highlighted in both the empirical and theoretical analyses has fed the public debate in academic and policy circles on the design of future monetary and macro-prudential policy interventions.
In one line of research, I have been exploring both theoretically and empirically the role of financial frictions in the firm-level investment and employment responses to monetary policy, and in particular changes in the interest rates. This has led to new theoretical analyses as well to the assessment of the predictions of well-known theories of financial frictions using micro data on firms’ balance sheet.

The focus of the project on household and firm heterogeneity using micro data has been particularly useful to study the economic consequences of the pandemic that abruptly and unexpectedly erupted in early 2020. This work has provided real-time analysis of the spending and saving behaviour of households using either high-frequency, granular bank account transactions data or the universe of mortgage originations covering both new mortgages and re-mortgaging activities. These analyses have led to the development of real time indicators that are currently in use by governments and policy institutions to monitor the developments of the pandemic crisis in the products and mortgage market.

The third strand of research has focussed on the working of the mortgage markets from the lender’s side, evaluating the effects of unconventional monetary policy such as the Bank of England’s Funds for Lending Scheme to promote private lending from commercial banks to private households and corporates. Furthermore, I have been using the universe of credit supply in the UK mortgage markets to explore the possibility that the relaxation of credit conditions seen in the early 2000s, together with low interest rates, played a key role in the accumulation of leverage in the housing market, which eventually led to the 2007-09 financial crisis. In one line of research, I have been exploring both theoretically and empirically the role of financial frictions in the firm-level investment and employment responses to monetary policy, and in particular changes in the interest rates. This has led to new theoretical analyses as well to the assessment of the predictions of well-known theories of financial frictions using micro data on firms’ balance sheet.
My research is leading to the development of a novel approach in which households interviewed in survey data or firms in balance sheet datasets are grouped according to some slow-moving characteristics (such as education or household debt position for households and age, leverage and dividend paying status for firms) for the purpose of identifying the groups in society more responsive to particular economic policy interventions such as monetary and fiscal policies or macroeconomic shocks such as the pandemic.
My research has advanced our knowledge on the mechanisms through which a large shock such as covid-19, monetary policy and fiscal policy transmits to the real economy through affecting the expenditure behaviour of particular groups of households and firms. My research has led to the development of real-time indicators to monitor the real economy (and especially consumer spending and mortgage markets) that are currently in use by the UK government. Inspired by this line of research that I have contributed to build, similar real-time indicators have been constructed for the United States and most other European countries to support government decisions in real-time.


As for theory evaluation, the hypothesis that financial frictions may alter the transmission of monetary and fiscal policy has not received much attention in the data, typically due to lack of sufficiently detailed micro data on both the household and firm side. Furthermore, the theoretical predictions are ambiguous as some theories (e.g. neoclassical framework) would predict that financial frictions should dampen the effects of monetary policy whereas other theories (e.g. financial accelerator) would suggest amplification. Combining rich data sets available at the household and firm level together with state of the art identification strategy for macroeconomic shocks, my research has been able to establish not only that financial frictions are likely to amplify the effects of monetary policy but also to quantify the magnitude of this channel in a way that can be used by governments, central banks and other academics as base for their model evaluations and simulations.
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