Credit risk, liquidity risk and the Quantity Theory of Money.

The objective of my research is to explain the connection between money supply and inflation, which underwent a significant structural change after the 2008 financial crisis. Following the crisis, the BoE, FED, ECB, and other major central banks implemented Quantitative Easing and significantly increased the reserve accounts of commercial banks. The supply of money (M0) in the UK tripled in 2008-2009 and increased by more than six times by 2015. According to the Quantity Theory of Money, this should lead to hyperinflation. However, UK inflation stayed within the target level (below 3%) until 2020 due to a change in monetary transmission performed by commercial banks. To explain the effect of money supply on inflation, we need to study the relationship between the growth of reserves, controlled by the Bank of England, and the money used for economic transactions. Those funds include deposits created within the fractional-reserve banking system. The reserve expansion is only efficient if banks use them and provide credit to the real economy. I intend to uncover the factors that influence this process. First, I will study the effect of credit and liquidity risks on monetary transmission. Banks operating in a riskier environment are more reluctant to provide loans to households and businesses, which slows down monetary transmission. I expect to find quantitative support for this theory by conducting empirical research. Then, I will evaluate different macroprudential policies using the dynamic stochastic general equilibrium (DSGE) framework