TAKING SERIOUSLY FINANCE Macroeconomics after the crisis Robert BOYER Conference “Toward an alternative macroeconomic analysis of microfoundations, finance-real economy dynamics and crises”, Budapest, September 6-8 th, 2010

INTRODUCTION The core arguments of this presentation  The failure of contemporary macro-modeling dates back to the inadequate formalization of General Theory  The irrelevance has been widening with the neo-Walrasian conception embedded into RBC and DSGE models  This is especially detrimental since the present crisis largely originated from a cluster of financial innovations with a large destabilizing role at the macro level

 There is an opportunity for developing new macroeconomic paradigms that would build upon: An updating of political economy analyses of financial crises An updating of political economy analyses of financial crises A clear compatibility with the major stylized facts exhibited by the history of financial crises A clear compatibility with the major stylized facts exhibited by the history of financial crises The formalization of some robust mechanisms linking finance to economic activity. The formalization of some robust mechanisms linking finance to economic activity.

 The presentation proposes at least four strategies: Modeling the contemporary finance-led regimes within an institutional macro theory Modeling the contemporary finance-led regimes within an institutional macro theory Formalizing the resilience and crisis of financial networks Formalizing the resilience and crisis of financial networks Extending a model of stock market bubbles to the banking system and the real economy Extending a model of stock market bubbles to the banking system and the real economy Learning and forgetting the origins of crises at the micro and institutional levels. Learning and forgetting the origins of crises at the micro and institutional levels.

I. The failure of contemporary macro- modeling dates back to the inadequate formalization of General Theory

Figure 1 – Half a century in macroeconomic theorizing

II. The irrelevance has been widening with the neo-Walrasian conception embedded into RBC and DSGE models

Table 1 – From the failures of DSGE models to new research agenda

III. This is especially detrimental since the present crisis largely originated from a cluster of financial innovations with a large destabilizing role at the macro level

Figure 2 – The recurrence of bubbles and financial crises: a synthetic index

Figure 3 – Growth of Assets of Four Sectors in the United States (March 1954 = 1) (Log scale) (source: Federal Reserve, Flow of Funds, )

Figure 4 – Household Sector Leverage and Total Assets (Source: U.S. Flow of Funds, Federal Reserve, )

Figure 5 – Broker Dealer Sector Leverage and Total Assets (Source: U.S. Flow of Funds, Federal Reserve, )

Table 2 – Various research programs facing the major stylized facts revealed by the present crisis

IV. An updating of political economy analyses of financial crises

Table 4 – Back to the political economy of financial crises

V. Taking into account some robust mechanisms linking finance to economic activity

Figure 6 – US Private Demand Growth and the Credit impulse 1.The procyclicity of credit and economic activity

2. The Yield Curve and Future Economic Activity Figure 7 – Forecasted probability of recession based on the slope of the yield curve 4 quarters earlier

3.The related Mechanisms: Impact upon the Shadow Banks Credit Supply via Profitability Table 3 – A macro financial intermediary VAR, US 1990 Q3 – 2008 Q3

Figure 8 – U.S. stock market and productive investment (% of GDP) 4.The impact of financial wealth upon the real economy

Figure 9 – U.S. Firms debt and stock market valuation (% of GDP)

Figure 10 – U.S.: total debt and financial and real estate wealth of household (% of real disposable income)

Figure 11 – U.S.: Total subprime credit (billion dollars) and housing prices (100 = )

VI. Modeling the contemporary finance-led regimes within an institutional macro theory

Figure 12 – An institutionally grounded macro modeling: A given configuration of a capitalist economy

Figure 13 – The Channels of finance to real economy in the era of finance led capitalism

VII. Formalizing the resilience and crisis of financial networks

Source: Gai Prasanna, and Sujit Kapadia (2010), p. 11, 22, 24. Figure 14 – The financial system as a network of assets and viabilities Figure 15 – The non linear impact of connectivity upon the default of banks Figure 16 – Capital buffers of banks may counteract the risk of default

VIII. Two other strategies  Extending a model of stock market bubbles to the banking system and the real economy  Learning and forgetting the origins of crises at the micro and institutional levels.

CONCLUSION C1 – The present crisis has revealed the many structural deficiencies of DSGE models: representative agent hypothesis, full rationality,…. C2 – Nevertheless its main weakness might well be the absence of a fully fledged financial system. C3 – This has been taking into account by the most recent researches within the DSGE paradigm. Can it succeed?

Table 4 – Recent extensions of GSGE models: at last “Banks matter”

C4 – The neo-Walrasian legacy of these models makes problematic the rescue of the DSGE approach: basic neutrality of money and underlying hypothesis of financial markets efficiency. C5 – This opens an opportunity for the emergence of old and new alternative paradigms but there are many of them. C6 – A discriminating criteria should be their respective ability to incorporate the basic mechanisms linking finance to real economy, while reproducing the major stylized facts exhibited by long run history of financial crises.

C7 – A possible dilemma: The search for a quite general model that could fit with all the previous financial crises, only the value of some parameters A special model coping with the specificities of the present crisis: the clustering of powerful financial innovations with strong negative externalities upon macroeconomic stability.

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