The Hedgehog and the Fox: From DSGE to Macro-Pru

Marcus Miller and Lei Zhang

Manchester School, 2015, vol. 83, 31-55

Abstract: type="main">

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.

Date: 2015
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