Tsotne Marghia, of the Class 2018, decided to apply for an MA research scholarship at the Shota Rustaveli National Science Foundation, following in the footsteps of another ISET student last year. Tsotne succeeded in being granted the scholarship, allowing him to purchase the necessary books and papers, as well as having the opportunity to attend conferences abroad.

The topic of his MA thesis is “Interdependence between Macroeconomic and Financial Stability Indicators: Macro-Feedback Effect”, a subject he decided to research after his internship at the National Bank of Georgia.

The international financial crisis of 2007-2008 has proved that financial stability is a key concept for understanding economic sustainability. Financial imbalances can lead to potentially harmful macroeconomic outcomes. Ignoring this concept may lead to misleading policy recommendations and decisions by policymakers.

The implementation of the Financial Sector Assessment Program – FSAP and Basel standards promoted the development of risk stress analysis. Stress tests are widely used for the analysis of conditions of the banking sector. The sustainability of a bank is dependent on systemic and idiosyncratic risk factors, creating the necessity for the investigation of credit risks and their decomposition. According to different studies, business cycles can influence banks’ balance sheets immediately or with some delay. At the same time, small attention is paid to the potential feedback from financial instability to the real economy, which can strengthen cyclical fluctuations, especially during a recession. Standard stress tests consider only the first-round effect from macroeconomic variables to financial stability indicators. Such an assumption is realistic for the explanation of short-run outcomes. However, in the medium and long term, shocks in the banking sector reflect macroeconomic indicators throughout different transmission mechanisms, such as the expectations of economic agents and the expected responses of the banking sector to increased credit risk.

Tsotne will conduct research aimed at constructing a macroeconomic model allowing the consideration of second round (macro-feedback) effects from the financial to the real sector, trying to prove the advantage of the expended model compared to standard stress-testing models. The study framework will strengthen macro-financial analysis by empirical analysis on the example of a small open economy country. The model might be used by the conductors of the monetary policy and banking sector supervisors for the estimation of credit risk with its macro-feedback effects. The study will allow the investigation of important empirical macro-financial linkages. For example, it will be possible to estimate the sensitivity of the GDP gap with respect to changes in financial variables and use it for the evaluation of the financial cycle. This procedure will help to extract business and credit cycles for enhancing risk analysis and comparing results regarding the calculation of gaps using Hodrick-Prescott and Kalman filters. At the same time, the model can be used for generating different scenarios and shocks for improving systemic risk analysis (the effect of the banking sector’s solvency on the real economy) and for providing better policy recommendations based on impulse response functions and historical shock decomposition.

Tsotne will present his work at multiple conferences, which will give him the opportunity to introduce his results to a wide audience.