The Role of Default in Macroeconomics

Charles A. E. Goodhart and Dimitrios Tsomocos
Additional contact information
Charles A. E. Goodhart: Norman Sosnow Professor of Banking and Finance, London School of Economics (email: c.a.goodhart@lse.ac.uk)

No 11-E-23, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: What is the main limitation of much modern macro-economic theory, among the failings pointed out by William R. White at the 2010 Mayekawa Lecture? We argue that the main deficiency is a failure to incorporate the possibility of default, including that of banks, into the core of the analysis. With default assumed away, there can be no role for financial intermediaries, for financial disturbances, or even for money. Models incorporating defaults are, however, harder to construct, in part because the representative agent fiction must be abandoned. Moreover, financial crises are hard to predict and to resolve. All of the previously available alternatives for handling failing systemically important financial institutions (SIFIs) are problematical. We end by discussing a variety of current proposals for improving the resolution of failed SIFIs.

Keywords: Default; Transversality; Money; Bankruptcy cost; Asset bubbles; Resolution mechanisms (search for similar items in EconPapers)
JEL-codes: B40 E12 E30 E40 E44 G18 G20 G28 P10 (search for similar items in EconPapers)
Date: 2011-09
New Economics Papers: this item is included in nep-ban, nep-cba, nep-hpe, nep-pke and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:11-e-23

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