FIRE

The current crisis was initially generated by a decrease of housing prices in the US. The subprime crisis had a global impact because toxic assets entered portfolios of private institutions. Today, we can note their financial and real effects, through the implications on the financial and real activities of many countries. The second main point that we learn from the current crisis is that it started as a local phenomenon, but propagated quite quickly all around the world. Because we live in a globalized world and markets are interdependent, it facilitated the transmission of the crisis, which started locally in the US, to the other countries. In this sense this crisis appears as quite different to the previous crises that occurred in the second half of the 20th century and that were much more local as affecting a limited number of countries (e.g. the Asian crisis of the 2000’s). There are however some similarities with the Great Recession of the 30’s with the notable difference that the propagation has been much faster nowadays as a consequence of a much stronger international market integration. The third main instruction concerns economic policies. While monetary and fiscal authorities first reacted using standards instruments and rules, there is now a consensus to conclude that we are in an exceptional economic situation, meaning that new economic policies should be considered. We can for instance have in mind the definition of new monetary rules or the design of fiscal policies with high levels of public debt. These three important aspects require us to understand more deeply the interdependencies between the financial and real spheres of economies. The real effects of asset volatility and bubble bursting should be investigated in the presence or not of financial imperfections. The transmission mechanisms to a globalized economy should be examined taking into account both real and financial spheres. Of course, in this context, new monetary and fiscal policies need to be designed. In this perspective, this project that focuses on the financial and real interdependencies will be organized according to the following three parts: Part 1 / Task 1. Real effects of bubbles and financial assets We focus on the valuation of financial assets and rational bubbles. We are concerned in their volatility and their real effects. A special attempt will be devoted to the implications of heterogeneous behaviors and financial frictions. This last part is addressed providing appropriate microeconomic foundations of the financial frictions. Part 2 / Task 2. Transmission mechanisms of international trade and openness We study the interplay between the financial and real spheres in open economies. We especially focus on the role of openness on asset valuation, bubbles and growth. Our goal is to examine the arbitrages that take place between the financial and good markets, the existence and propagation of speculative bubbles and the effects of capital inflows through international financial markets on growth. Part 3 / Task 3. The role of monetary and fiscal policies We aim to design the role of monetary and fiscal policies when the economy experiences business cycles and financial crises. One focuses on their stabilizing virtues, but also on the optimality of such policies. We are in particular concerned with economies characterized by strong levels of public debt and exceptional events, as it happens following a crisis.