Page 1

Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, RealityBased, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu. Weblog Home Page Weblog Archives Econ 115: 20th Century Economic History Econ 211: Economic History Seminar Economics Should-Reads Political Economy Should-Reads Politics and Elections Should-Reads Hot on Google Blogsearch Hot on Google Brad DeLong's Egregious Moderation August 09, 2009

Markus Brunnermeier on Which Macroeconomics for the Future? Markus Brunnermeier writes: Mind the frictions: BOB LUCAS rightly points out that a branch of macroeconomics proved very useful in weathering the recent crisis. Research by Ben Bernanke and Mark Gertler, Nobu Kiyotaki and John Moore, Rick Mishkin and other macroeconomists provided helpful policy guidance, exactly because their models emphasise the importance of financial frictions for the macroeconomy... I gotta protest. Not that Markus is wrong when he says that Bernanke-GertlerKiyotaki-Moore-Mishkin and their posse have been very useful in their analyses of financial frictions--they have. But the Chicago school simply does not believe such frictions are important. They believe, as Markus writes immediately afterwards: However, the bulk of macroeconomic research simply assumes financial frictions away. The financial system and its institutional details were often seen as a distraction from the main drivers of the economic activity. In these models the failure of a large financial institution, like Lehman, would be of no real consequence. But I think we can all agree--if we learnt one thing from the current financial turmoil it is that financial frictions and financial institutions are of essential importance for the macroeconomy... That's the reason Robert Lucas and company say that they "really don't get" the point of banking policies--they simply haven't read Bernanke-Gertler, Kiyotaki, Moore, and company. http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 1 of 6


Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

It is, after all, financial frictions and financial institutions that make banking policies and fiscal policies useful tools for fighting the current recession. Financial frictions make it socially beneficial to finance spending via government borrowing when it is not profitable to finance spending via private borrowing because of financial frictions that the government--as long as its debt remains the safe asset in the economy--can work around. Financial frictions make it socially beneficial to recapitalize the banking system rather than simply letting it fail. Markus goes on to play a little intellectual judo, saying that Lucas's endorsement of the stimulative monetary policies of Ben Bernanke is really an endorsement of Bernanke's credit-channel financial-friction approach to macroeconomics. It is a clever move, and I hope it succeeds. And Markus goes on to say a lot more clever and wise things: In my view these frictions are also the root cause for the failure of the efficient market hypothesis (EMH). For example, bubbles can emerge and persist due to limits to arbitrage. Of course, as Bob Lucas points out, when it is commonly known among all investors that a bubble will burst next week, then they will prick it already today. However, in practice each individual investor does not know when other investors will start trading against the bubble. This uncertainty makes each individual investors nervous about whether he can be out of (or short) the market sufficiently long until the bubble finally bursts. Consequently, each investor is reluctant to lean against the wind. Indeed, investors may in fact prefer to ride a bubble for a long time such that price corrections only occur after a long delay, and often abruptly. Empirical research on stock price predictability supports this view. Furthermore, since funding frictions limit arbitrage activity, the fact that you can’t make money does not imply that the “price is right�. This way of thinking suggests a radically different approach for the future financial architecture. Central banks and financial regulators have to be vigilant and look out for bubbles, and should help investors to synchronise their effort to lean against asset price bubbles. As the current episode has shown, it is not sufficient to clean up after the bubble bursts, but essential to lean against the formation of the bubble in the first place. This calls on us economists to further develop our tools (including mathematical tools) to integrate the insights financial economists have developed on frictions and the formation of bubbles into the fully fledged dynamic stochastic general equilibrium macro and monetary models that macroeconomists have been working with. Bringing financial economists, macro- and monetary economists together to take on this challenge of building a new workhorse model that incorporates financial frictions would be a great first step in this important (and exciting) endeavor. rated 4.44 by 6 people [ ? ] You might like: http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 2 of 6


Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

Lucas Roundtable: Ask the Right Questions(Economist's View) Jonathan Chait Tells David Broder and All the Other Clubby, Groupthinking Mediocrities of the Republican Press Corps What He Thinks of Them(this site) 2 more recommended posts Âť Brad DeLong on August 09, 2009 at 08:34 AM in Economics, Economics: Economists, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro | Permalink TrackBack TrackBack URL for this entry: http://www.typepad.com/services/trackback/6a00e551f0800388340120a4db64e9970b Listed below are links to weblogs that reference Markus Brunnermeier on Which Macroeconomics for the Future?:

Comments You can follow this conversation by subscribing to the comment feed for this post.

Shorter Brunnermeir "economists should integrate the hypOtheses that the earth is flat and that the earth is round" What is fully fledged about "fully fledged dynamic stochastic general equilibrium macro and monetary models" except for the assumptions that there are no frictions or bubbles ? If frictions and bubbles are important, what of value remains in fully fledged dynamic models ? What is the shared hypothesis of Prescott and Woodford except the assumption that frictions and bubbles can safely be ignored ? (Woodford concedes for the sake of argument). Posted by: robert waldmann | August 09, 2009 at 12:41 PM Read "Bernanke's Dark Kingdom." http://kingdom.yield-curve.net Abstract: I am going to show here that central banks have excessive powers which are coherent neither with democratic principles nor with morality. Their existence can not be justified from a mathematical point of view. Worse, in light of the exercise of their extraordinary power by Bernanke, I argue that they can pose a real threat to democracy, peace, privacy and individual freedom. Because of the immediate dangers that are evoked in these lines I strongly suggest that you reproduce my deeds. "I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively.

http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 3 of 6


Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—- objections which, I will argue, could be overcome if the will to do so existed." Prof. Ben Shalom Bernanke Japanese Monetary Policy: A Case of Self-Induced Paralysis? http://www.princeton.edu/svensson/und/522/Readings/Bernanke.pdf For Presentation at the ASSA Meetings, Boston MA, January 9th, 2000. The Purpose of My Yield Curve. is to promote a plausible alternative to economic depression, The Adjusted Credit Free, Free Market Economy, our New Economic Order. http://blog.yieldcurve.net It is a fair, prosperous and stable economy that protects its participants from the consequences of the inevitable crash of proportions never heard of and from the Deep Depression that will ensue and which will follow a gicantic Asset Price Bubble. That economy is both liberal and libertarian. That New Economic Order does not discriminates and guarantees the individual freedoms of its participants. In order to reserve your option to participate you just need to register anonymously, before The Crash, the serial number of a €5 bank note in our Public Cra$h R€gi$t€r It is Free!. http://crash-register.yield-curve.net Posted by: Shalom P. Hamou | August 09, 2009 at 03:26 PM My hunch is that this is wrong, and expecting more leverage, and unlimited shorting, to lead to a better financial system is wrong. A financial system needs to do three things: channel investment, provide insurance, provide liquidity. Investment is a positive-sum activity, insurance is a zero-sum activity that increases welfare because most people are risk&uncertainty averse, and I'm not sure what liquidity is. How can shorting, which is a zero-sum activity that provides neither insurance nor liquidity, AFAICS, increase welfare? The only people who should make money from shorting are the bookies providing shorting services; the actual bettors should on the whole lose money, as they need to pay the house. The reason this might not have happened is that Wall Street, I suspect, has evolved a Globetrotters versus Generals culture, where the Globetrotters convince the Generals who provide the shorting and insurance services, to do so on favorable terms which are good for the Globetrotters, and perhaps good for the Generals personally, but bad/disastrous for the institutions the Generals run. I guess I'm doubling down on the belief that too much liquidity is a bad thing, and that some friction, ala a Tobin & transactions tax, will both be a useful way to raise revenue, and may even slightly increase the performance of the financial system, perhaps by reducing volatility, and perhaps by encouraging the Princes of Wall Street to make their money via core strategies of investment, insurance and (some) liquidity, and not non-core strategies which rely on zerosum betting and double super reverse arbitrage leveraged 50 times over. Brunnermier is basically saying that the problem is that someone who shorted Amazon at 80 got killed when it zoomed up to 400, even though it's fundamental value was 20 (say). So he seems to be envisioning a system where a righteous, on-the-side-of-the-angels shorter should be able to go to the Fed and avoid meeting a margin call, if the fundamentals are on the shorter's side. Is that what he's saying?

http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 4 of 6


Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

I think, for now, I'll stick with Tobin (& Vickrey, Mirlees, Akerlof, Baumol, etc.) over the moderns, thanks. Posted by: roublen | August 10, 2009 at 01:00 AM The basic problem is that investing for interest/rent/dividends got replaced by the Ponzi Paradigm, which in turn got replaced by a combination of leverage & Globetrotters v. Generals. The problem in shutting down a dotcom-style bubble is not a new problem: you have to shut it down in the same way you shut down any Ponzi scheme. I'm not really sure what the traditional ways to deal with Ponzi schemes were, but surely they exist. Posted by: roublen | August 10, 2009 at 01:47 AM No comprendo on the meaning of the word "posse" in this context. Posted by: Nancy Kirsch | August 14, 2009 at 08:31 AM

Verify your Comment Previewing your Comment Posted by: | This is only a preview. Your comment has not yet been posted. Post

Edit

Your comment could not be posted. Error type: Your comment has been posted. Post another comment The letters and numbers you entered did not match the image. Please try again. As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments. Having trouble reading this image? View an alternate. Continue Me:

Economists: Juicebox Paul Mafia: Krugman Ezra Klein Mark Matthew Thoma Yglesias Cowen and Spencer Tabarrok Ackerman Chinn and Dana Hamilton Goldstein Brad Setser Dan Froomkin

Moral Philosophers: Hilzoy and Friends Crooked Timber of Humanity Mark Kleiman and Friends Eric Rauchway and Friends John Holbo and Friends

http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 5 of 6


Markus Brunnermeier on Which Macroeconomics for the Future?

8/19/09 12:50 PM

Bernanke's Debt Solution Central Banks To Change Value Of Money - What It Means For You. UncommonWisdomDaily.com/Economic

http://delong.typepad.com/sdj/2009/08/markus-brunnermeier-on-which-macroeconomics-for-the-future.html

Page 6 of 6


Markus Brunnermeier on Which Macroeconomics for the Future  

The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality- Based, and More than Two-Handed Look at the World J. Bradford De...

Advertisement
Read more
Read more
Similar to
Popular now
Just for you