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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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VI Conclusions and Some Free Thoughts on Money, Banking and Macroeconomics


Chapter VIConclusions and Some Free Thoughts on Money, Banking and Macroeconomics

During the Great Moderation (the period between the mid-1980s and 2007), the USA experienced unusual macroeconomic stability together with significant growth in asset prices and a shift in the distribution of credit to the financial and real estate sectors of the economy. In retrospect, this trend contributed to financial fragility; and, the bubble burst in 2007–2008. The crisis and the great recession that followed the crisis was an unexpected transition of the economy from one state to the other and caught many by surprise.

The mainstream macroeconomists had taken a benign view of the SMM prior to the crisis. The crisis made it clear that this view was mistaken, and a thorough and careful reassessment of the SMM is now warranted.

The crisis also highlighted some anomalies in the mainstream macroeconomic approach. An important one among them, discussed in this book, is the persistent and significant instability and decline in the velocity of money since the 1980s in most of the developed economies of the world. This renders the main conclusions of the quantity theory of money invalid.

Against this background, the book presents a critical review of the SMM approach as reflected in the family of DSGE models. It notes that, firstly, the approach has failed to capture the complex and dynamic nature of the monetary and financial sectors of the economy. Secondly, the role of banks, as portrayed...

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