During the global financial crisis and ensuing Great Recession, economists at policy-making institutions had little choice but to augment macroeconomic models with ad-hoc assumptions and adjustments in order to provide analysis and advice for policy makers. The MACFINROBODS consortium aims to move policy-focused macroeconomic modelling beyond this approach to the endogenous modelling of the dynamics resulting from financial risks and related decision making in banks, households, firms and public institutions. Most importantly the consortium aims to help improve model-based policy analysis at the following institutions:
Macroeconomists have been criticized for failing to predict the Great Recession of 2008 and 2009 or at least failing to provide adequate warning that global financial disruptions could trigger such a massive contraction. Practitioners and influential researchers (see, for example, Buiter (2009), Krugman (2009)) have questioned the usefulness of macroeconomic research and training over the last three decades and blamed academic and central bank researchers’ focus on dynamic general equilibrium modelling for misdirecting the attention of policymakers. However, the Nobel committee awarded the 2011 Prize in Economic Sciences to Thomas Sargent and Christopher Sims "for their empirical research on cause and effect in the macroeconomy".
Against this background, researchers are still debating whether to re-invent macroeconomic and financial modelling from scratch or to improve existing frameworks that have already been used to inform policy makers. The researchers of the MACFINROBODS consortium plan to pursue a systematic, comparative approach to model design that is open to competing paradigms and aims to deliver robust policy prescriptions. They intend to address the problem of modelling uncertainty by searching for policy settings and rules that perform well across a range of diverse representations of the macroeconomy. This approach acknowledges and exploits diversity.
In his opening address to the European Central Bank’s annual conference on 18 November 2010, former ECB President Jean-Claude Trichet expressed the need for such an approach very clearly:
”We need macroeconomic and financial models to discipline and structure our judgemental analysis. How should such models evolve? The key lesson I would draw from our experience is the danger of relying on a single tool, methodology or paradigm. Policymakers need to have input from various theoretical perspectives and from a range of empirical approaches. Open debate and a diversity of views must be cultivated ... We do not need to throw out our DSGE and asset-pricing models: rather we need to develop complementary tools to improve the robustness of our overall framework”.
Clearly, macroeconomic and financial researchers have not been complacent since the beginning of the global financial crisis and much work on more realistic modelling of financial risks and their implications has been accomplished. Nevertheless, much greater effort is still needed to effectively integrate emerging insights on human decision-making under risk and uncertainty and on the institutional features and fragilities of financial intermediation into policy-focused macroeconomic models. There are still many topical and policy-relevant questions that are dealt with on the basis of ad-hoc adjustments to policy models, namely by adding on exogenous dynamics rather than modelling the endogenous determination of the dynamics resulting from financial risks and related decision making in banks, households, firms and public institutions.