The Bankers’ New Clothes: Banking Influence on Macroeconomics

Upon reading Simon Wren-Lewis’s blog post this past week I stumbled across several websites, articles,  and videos pertaining to economic faults as a results of risky banking practices. I was initially directed to this website which then lead me to to other sources. I found a lot of the information to be interesting so I figured I share it with you all.

Anat Admati, the main contributer to the works I found, is the George G.C. Parker Professor of Finance and Economics at
the Graduate School of Business, Stanford University. She has written a book called The Banker’s New Clothes, which takes an in-depth look at risks in banking and how those risks can impose significant costs on the economy. “Weak regulation and ineffective enforcement allowed the buildup of risks that ushered in the financial crisis of 2007-2009. Much can be done to create a better system and prevent crises” (Admati). The role of the financial & banking sector is something that I have been looking into the past few weeks; Admati has a lot to contribute to solve a problem that authors we all have encountered so far, Farmer and Wren-Lewis, have talked about. In my previous blog post Wren-Lewis talked about how an increase in bank capital requirements can help avoid future banking crises, which is an idea that Admati has proposed and researched.

I have also linked two short videos below that explain Admanti’s and her colleague Martin Hellwig’s take on the banking system and its influences on the macroeconomy.

Short Video:

StanfordTedx Presentation:

RE: Attacking economics is a diversionary tactic

Simon Wren-Lewis is a professor of Economic Policy at the Blavatnik School of Government, Oxford University. Below is a brief summary and what I thought about his recent blog post: Attacking economics is a diversionary tactic.

Simon Wren-Lewis’s preliminary thoughts explain that the financial crisis in the UK was a result of the loss of financial assets, specifically in the shares of the US subprime market due to the housing market collapse in 2008. Similar to Roger Farmer, Wren-Lewis critiques mainstream macroeconomists and their exclusion of the financial sectors and the leverage it has in the macroeconomy. Dramatic increases in bank capital requirements are proposed as a viable solution to future banking crises but Wren-Lewis tells us that banking lobbies are too powerful and that there is a lack of consensus between policymakers and economists.

He criticizes both sides of heterodox economists, neoliberals & right-wing. He calls the neoliberal idea economics bowdlerized and the right-wings to be in denial and politically biased.

There seems to be a relatively positive outlook on economists in general throughout the blog post. Wren-Lewis expands on the idea that economists do far more good for the macroeconomy than bad. He explains that the wrong predictions of a few economists shouldn’t reflect the success of the others. “Attacking economists over Brexit is designed to discredit those who point out awkward and uncomfortable truths” (Wren-Lewis).

I agree with Wren-Lewis on a lot of the points he made. I believe that most macroeconomic and financial inefficiencies are the result of political and social constraints. To a certain degree, more trust must be placed in economists in executive positions. We should acknowledged success as much as failure, but also strive for fundamental progression.


Roger Farmer: DSGE Models, Easing Crises, & the Farmer Monetary Model

Roger Farmer in chapter 8 of Prosperity For All expands of the New Keynesian DSGE models that central bankers and firms relied on for the past couple decades. He explains that their reliance on their DSGE models “gave policymakers a false sense of security” (Farmer, 111). He explains that New Keynesian DSGE models are self-stabilizing and that after a shock to one of the models equations the unemployment rate returns to steady-state values, but as Farmer argues, the unemployment rate in US data does not return to fixed numbers. This is one of several examples of how the models used today are flawed on the basis of theory and methodology. Although it might be extremely difficult, Economists must work as a collective and agree on basic principles of models in order for them to forecast business cycle fluctuations and recessions.

Farmer proposes the ideal model to explain the effects of monetary policy on inflation and unemployment in Chapter 6 & Chapter 8 pages 127. He calls the model the Farmer Monetary Model, which he claims can explain the Great Moderation and the Great Recession. The model is essentially a combination of the Keynesian search model and money of asset markets. The model is explained in-depth in chapter 9 and includes the equations, variables, paramters, and shocks on pages 150-153.

An addition to the idea preventing and/or easing the burdens of financial crises, Farmer proposes that the the central bank should act as an agent for the US Treasury and should intervene in asset markets. This intervention is explained through the process of buying or selling shares in an exchange-traded fund (ETF) in the stock market in response to the unemployment rate. Ultimately, the central bank would buy shares in the ETF if unemployment was high and sell if it was low. Monetary policy targets inflation rates and Farmer’s proposed financial policy would target the unemployment rate (Farmer, 19).

Farmer explained DSGE Models
Dynamic: Past values and beliefs about future values of economic variables influence their current values
Stochastic: Random shocks hit the economy in every period
General Equilibrium: Each equation within the model are derived from assumptions about the behavior of rational human beings interacting in markets to reach an equilibrium (Farmer, 110)

New Keynesian DSGE models function within three equations; New Keynesian Investment Equals Savings (IS) Curve, the Taylor Rule, and the New Keynesian Phillips Curve (Farmer, 113). The equations, variables, shocks, and parameters of the New Keynesian model is explained and shown in Chapter 8 pages 127-130.

What is your model of the macro economy? What is the model in your head?

My model for the macro economy is to comprehensively include all of the ins and outs of an economy that can be manipulated in order to predict outcomes of various macroeconomic situations. Variables in this model include GDP growth rate, technological advances, market failures, trade surplus and deficits, investments, inflation, predictions, etc. The model will have to be very complex and would include several other interconnected models to output more accurate results. Models such as DAD-DAS can be used along with Income Expenditure and the Neoclassical Growth Model. Results would also include important markets that influence our economic progress. These markets include but are not limited to the housing, stock, and manufacturing markets. The model will also take in account monetary and fiscal policy. Both forms of policy are instrumental in how our economy is functioning and both must work together and be complimentary of each other to achieve the most optimal results. The model as a whole must be based on mathematical equations and be derived from theory that has been continuously proven to be true. I believe that economic models, and economics as a field, are seen to be conclusive and free from error which is not necessarily the case. Models should be tweaked and improved over times as knowledge surfaces and challenges the status quo. Theories and models should be based on real-life scenarios and should not neglect outliers. Economic anomalies should be studied further and used to advance models and inferences. The health of the overall economy is dependent on many different variables and leaving any of them out is neglectful and can lead to both unpredictable and devastating outcomes.