The growth of emerging economies and global macroeconomic stability

University Of Southern California, Los Angeles CA

Investigators

Abstract

During the last 30 years, the world economy has seen unprecedented economic growth in a group of 'emerging countries'. During the same time period, these countries have accumulated positive net positions in safe financial assets. This award funds research in macroeconomics that builds and analyzes a new model to investigate how the resulting increase in demand for safe assets from emerging countries affects macroeconomic stability. This includes effects on both industrialized nations and emerging countries. The research also considers whether this change in the demand for safe assets increases the need for macroeconomic policy interventions. The project will advance science by helping us understand the role of banks in issuing liabilities and the mechanisms behind the sever employment consequences of financial crises. It will advance national prosperity by providing new insight into whether or not policy interventions are desirable. The model has financial intermediaries playing a central role in the intermediation of funds from agents in excess of funds (lenders) to agents in need of funds (borrowers). In this process financial intermediaries issue liabilities and make loans. Bank liabilities are held for insurance purposes by other economic sectors; they affect individual economic decisions when these decisions involve significant risk. When the banking sector expands, agents in the nonfinancial sector hold more financial assets, are better insured, and are more willing to engage in economic activities that are individually risky but desirable in the aggregate. As a result, the economic grows. However, there is a downside. In the process of issuing more liabilities, the intermediation sector becomes exposed to liquidity crises. Therefore, there is a trade-off for policy between the benefits of an expanded financial system and the costs of greater financial and macroeconomic instability. The project studies the desirability of policy interventions in the presence of this trade off.