The Hedgehog and the Fox: From DSGE to Macro‐Pru1. (September 2015) - Miller, Marcus
Abstract : Prior to the financial crisis of 2008/9, DSGE models‐without‐money set a new standard in applied macroeconomics; and they were widely adopted by Central Banks to help achieve their inflation targets. Controlling inflation did not deliver financial stability, however: far from it. The appeal of macro‐models based on 'efficient financial markets' surely contributed to over‐confidence before the crisis. But what about externalities? We examine, in particular, how steps to mitigate microeconomic principal/agent problems can create macroeconomic externalities—'financial accelerators' that affect balance sheets in pro‐cyclical fashion. Now is the time, we argue, to embrace such a wider perspective.