Understanding Macroeconomic Fragility

The 2008-2009 worldwide financial crisis has reminded us all, that economic systems can be quite fragile. Understanding this fragility is crucial in order to formulate appropriate policy responses and strategies for the future, such as macro-prudential regulation, but also for identifying the private-sector risks and opportunities arising out of this fragility. The first part of the project will provide insights into how the lending market and resale market for asset-backed securities could have broken down, leading to a near-collapse of the banking sector and to a significant decline in real loan activity. The key will be the sudden realization by market participants, that these assets differ in quality, thereby throwing sands in the wheels of short-term financing of these asset trades. The second part of the project will investigate market “liquidity”, market “freezes” and “overheating”, using concepts developed in statistical mechanics for similar phenomena in physics, to provide deeper insights into these phenomena, and their macroeconomic implications.