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SAMØKONOMI-Makroøkonomiske utfordringer

Inequality, debt, and crisis management

Alternative title: Ulikhet, gjeld og krisehåndtering

Awarded: NOK 12.0 mill.

The years leading up to the 2008-2009 Financial Crisis were associated with large and increasing imbalances in the U.S. housing market stemming from increases in household debt and in house prices. The consensus among economists is that these imbalances were crucial ingredients in making the recession deep and long lasting. These increases in imbalances went hand in hand with a rising economic inequality, and a growing number of households ? the subprime borrowers ? were highly exposed to changes in house prices. This consensus begs the question of how policy should be tailored to avert a similar crisis in the future. This project studies how to monetary policy and financial regulation to reach this aim. The project will use data to document empirical facts about how the current government policies ? especially monetary policy and bank loan regulation ? impact and are impacted by the presence of growing economic inequality. The project will draw on high-quality Norwegian administrative data. In particular, these data allows us to study detailed family relationships, addressing empirical questions that are not feasible to explore outside of Scandinavian countries. In light of the unfolding economic crisis caused by the Corvid-19 pandemic, the project will be able to study details about how the behavior of the entire distribution of individual households and firms as the economic crisis unfolds. The project has four parts. First, we will develop a new framework for macroprudential policy for household debt which will lower the cost of debt regulation and simultaneously increase its effectiveness. Second, we will study how monetary policy should change as the population becomes older. Third, we will investigate how firms? investments are influenced by monetary policy changes . Fourth, we will study monetary policy in light of the fact that fiscal policy is inherently nominal, resting on fixing fiscal budgets one year in advance.

Motivated by the rising economic inequality and the role of household debt and house prices during the 2008-2009 Great Recession, this project analyses how heterogeneity across households and firms interacts with (1) Macroprudential Policy and (2) Monetary Policy. Inequality and incomplete markets are the hallmarks of the project. On the one hand, the project will use data to document empirical facts about how the current government policies – especially monetary policy and bank loan regulation – impact and are impacted by the presence of heterogeneity and inequality. The project will draw on high-quality Norwegian administrative data, which allows us to study deep and detailed empirical relationships that are not feasible to explore outside of Scandinavian countries due to lack of such data availability. In light of the unfolding economic crisis caused by the Corvid-19 pandemic, the project will be able to study details about how the behaviour of the entire distribution of individual households and firms as the economic crisis unfolds. The project has four parts. First, we will develop a new framework for macroprudential policy for household debt. Based on a novel financial instrument, this framework will lower the cost of debt regulation and simultaneously increase its effectiveness. We will also document who bears the house price risk and how unevenly this risk is distributed across households. Second, we will study how optimal monetary policy changes as the population becomes older. Third, we will explore the role of heterogeneity across firms in understanding how firms’ investments are influenced by monetary policy changes. This will shed new light on the aggregate investment dynamics. Fourth, we will develop a new framework to study monetary policy in light of nominal fiscal policy – resting on short-term fiscal budgets and incomplete markets.

Funding scheme:

SAMØKONOMI-Makroøkonomiske utfordringer