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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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III Endogenous Money, Minskian Financial Crises and the Balance Sheet Recession: Resolving Puzzles and Anomalies


Chapter IIIEndogenous Money, Minskian Financial Crises and the Balance Sheet Recession: Resolving Puzzles and Anomalies

The financial crisis of 2007 brought an abrupt end to “The Great Moderation,” a long period of economic stability, which had lasted since the mid 1980s (Bernanke 2004; Davis and Kahn, 2008; Gali and Gambetti, 2009). The Great Moderation not only saw unusual macroeconomic stability, but also a rise in asset prices and strong growth in credit in relation to output. Importantly, there was a marked shift of credit flows to the financial sector compared to the real sector.

Significant shifts in credits during a credit boom, from relatively low-risk, low-return investments in the real sector to high-risk, high-return ones in the financial sectors (real estate and financial assets), can increase the financial fragility of the system (Beck et al, 2012). Shifts in credit flows to the financial sector diminish its link with output growth (Tobin, 1984). In its final phases, before the bust, credit growth coupled with rising asset prices started reinforcing each other, and credit growth was no longer driven by market fundamentals (Bezemer and Grydaki, 2014, Allen and Gale, 2000).

A persistent and significant drop in the velocity of money since the 1980s has been another important trend. The puzzle of unstable velocity, which remained unresolved for a long time, also has links to developments in the credit markets that lead to recessions and crises.

The standard macroeconomic model (SMM), by not taking into...

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