Abstract:
This thesis examines three aspects of the global financial crisis: the pre-crisis buildup of bank fragility and the role played by US monetary policy; the market mayhem triggered by asset managers in the wake of US monetary policy normalisation following the crisis; and the labour market consequences of a withdrawal of bank credit following re-evaluation of financial collateral by investors. Using theoretical and empirical methods I show that, while each of these episodes appear as outcomes of an interchange of optimism and panic, they can be interpreted as rational responses by market participants to deep frictions within the economy. Specifically, I find that (i) there is evidence of a global financial cycle in which loose US monetary policy heightens the default risk of banks in other countries; (ii) market panics and the equilibrium allocation of arbitrage capital hinge on the stance of monetary policy. Since arbitrage pro ts depend on expectations of future crises, which are contingent on the actions of central banks, asset managers keen to keep up with their peers may race to sell assets at the same time; (iii) worsening collateral quality does not always trigger screening by banks but, when it does, employers are deprived of funds to hire, triggering job losses. The analysis contributes to the wider debate on the use of monetary and macroprudential policy to foster financial stability.