Rethinking sources and consequences of business cycles

Starting Grant (StG), SH1, ERC-2012-StG

Project acronym: RESOCONBUCY

Project: Rethinking sources and consequences of business cycles

Researcher (PI): Fabrizio Perri

Host Institution (HI): Universita Commerciale Luigi Bocconi, Italy

Start date: 2012-12-01, End date: 2017-11-30

Summary: «Up until 2006 most macro-economists held the view that combination of technology and monetary factors could explain the bulk of business cycles, and that overall business cycle fluctuations were not a major source of concern for policy (at least in developed economies and in the post-war). The 2007-2009 crisis and its aftermath has radically shaken this view. First, most industrialized countries have experienced the largest and more synchronized downturn since the great depression and neither productivity nor monetary factors seem to have played a major role in it. Second the downturn has left profound scars on developed economies, in particular it has left a combination of high unemployment, large fiscal deficits, sluggish and unbalanced growth which are causing serious social discomfort together with political and international instability. The goal of this proposal is to better understand causes and consequences of the crisis. I intend to work on the 6 specific projects outlined below. All 6 projects are empirically motivated by the great depression and surrounding events, and all projects try to draw relevant policy implications from the analysis. On the causes of the 2007-2009 crisis: i) Wealth and volatility. The project explores the role of self-fulfilling demand crises as a drivers of business cycles. Main finding is that situation in which asset prices (in particular housing prices) are low makes the economy more vulnerable to these crises. ii) Spatial Business Cycles. Project shows that increase in unemployment did not hit all US counties at the same time but rather started in few counties and over time spread to neighbouring areas. We draw lessons for the importance of housing prices and other local factors in causing, transmitting and amplifying fluctuations. iii) Dealing with International Financial Distress. Early work has shown that financial shocks can cause global decline and that they can emerge endogenously as confidence crisis in the global market for asset of defaulting firms. This project asks whether and how policies can avoid these confidence crises, keeping into account that policies of liquidity provision might increase risk taking. iv) The international China Syndrome. The project explores the role of new emerging manufacturing powerhouses such as India or China on macroeconomic performance of developed economies both from an empirical and a theoretical point of view. On the consequences of the 2007-2009 crisis i) Inequality and the Great Recession. Project analyzes the distributional impact of the crisis and of the persistent unemployment in the US, using data on inequality in income, hours, wealth and consumption over the period 2005-2011. ii) Understanding the Euro debt crisis of 2011. This project uses a standard model of international limited risk sharing to assess whether the recent surge in sovereign spread paid by many European countries can be explained by macro fundamentals.»