I have been discussing needed research in microeconomics and financial economics but have not yet touched on macroeconomics. Standard macroeconomic models, such as the workhorse new-Keynesian model, did not predict the crisis, nor did they incorporate very easily the effects of financial instability. Do these failures of standard macroeconomic models mean that they are irrelevant or at least significantly flawed? I think the answer is a qualified no. Economic models are useful only in the context for which they are designed. Most of the time, including during recessions, serious financial instability is not an issue. The standard models were designed for these non-crisis periods, and they have proven quite useful in that context. Notably, they were part of the intellectual framework that helped deliver low inflation and macroeconomic stability in most industrial countries during the two decades that began in the mid-1980s.
That said, understanding the relationship between financial and economic stability in a macroeconomic context is a critical unfinished task for researchers. Earlier work that attempted to incorporate credit and financial intermediation into the study of economic fluctuations and the transmission of monetary policy represents one possible starting point. To give an example that I know particularly well, much of my own research as an academic (with coauthors such as Mark Gertler and Simon Gilchrist) focused on the role of financial factors in propagating and amplifying business cycles. Gertler and Nobuhiro Kiyotaki have further developed that basic framework to look at the macroeconomic effects of financial crises. More generally, I am encouraged to see the large number of recent studies that have incorporated banking and credit creation in standard macroeconomic models, though most of this work is still some distance from capturing the complex interactions of risk-taking, liquidity, and capital in our financial system and the implications of these factors for economic growth and stability.
It would also be fruitful, I think, if "closed-economy" macroeconomists would look more carefully at the work of international economists on financial crises. Drawing on the substantial experience in emerging market economies, international economists have examined the origins and economic effects of banking and currency crises in some detail. They have also devoted considerable research to the international contagion of financial crises, a related topic that is of obvious relevance to our recent experience.
Finally, macroeconomic modeling must accommodate the possibility of unconventional monetary policies, a number of which have been used during the crisis. Earlier work on this topic relied primarily on the example of Japan; now, a number of data points can be used. For example, the experience of the United States and the United Kingdom with large-scale asset purchases could be explored to improve our understanding of the effects of such transactions on longer-term yields and how such effects can be incorporated into modern models of the term structure of interest rates.
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