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Money Matters

Some Puzzles, Anomalies and Crises in the Standard Macroeconomic Model

Syed F. Mahmud, Kaoru Yamaguchi and Murat Yülek

The 2007 financial crisis and the Great Recession have prompted a debate about the state of macroeconomics, and many orthodox economists have argued that macroeconomics has entered a Dark Age.

This book discusses the shortcomings of the standard macroeconomic model (SMM). The SMM failed to explain the real world and anticipate the global financial crises. The main reasons for this failure have been attributed to its inability to assign an active role of money and by the absence of appropriate modelling of financial markets.

The book also discusses how the SMM can be reformed to better account for the real world and policy prescriptions, such as the Chicago Plan, that can reduce the risks emanating from excessive money creation by banks.

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I Introduction

Extract

Chapter IIntroduction

The advent of the global financial crisis that started in 2007–2008 took not only millions, perhaps billions, of people by surprise, but also a host of economists, policy makers, regulators and international institutions. It was evident that reliance on the “standard macroeconomic model” (SMM) simply led to a failure to predict the crisis.

It is important to note that the crisis followed a long period of “great moderation” (Stock et al., 2002) characterized by a significant decline in macroeconomic volatility and stable inflation. Many economists believed that the history of severe economic crises had ended. For example, Olivier Blanchard (2008), the Director of Research at the International Monetary Fund, concluded that the “state of macro was good,” and a “broad convergence of vision” was now achieved. Similarly, Nobel laureate Robert Lucas (2003) now believed that “things were under control” and the “central problem of depression-prevention has been solved.” Another former Chairman of the Fed, Ben Bernanke, attributed the success of economic performance during the Great Moderation to improved policy making.

Is the model flawed or are we just facing a tail risk?

Following the emergence of the crisis, however, Alan Greenspan, another former Chairman of the Governors of the Federal Reserve Bank (Fed), admitted in 2008 that the mainstream approaches to the workings of the financial←23 | 24→ markets were flawed1. Nobel laureate Joseph Stiglitz (2011) pointed out that the SMM not only failed to predict the current crisis,...

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