A couple of weeks ago Martin Wolf blogged on the way in which modern macroeconomics has neglected the explicit and integrated treatment of the financial sector. The consequences of this omission have turned out to be of enormous practical significance. It left analysis mostly blind to a range of important real world developments. He provided a brief summary of the characteristics of the banking system that he considers economics students need to be familiar with.
This is a theme developed by Professor Wendy Carlin in the revision of her textbook currently under development. She blogged about the aim of the project a year ago. The revision seeks to move instruction beyond a three equation model which does not explicitly incorporate money or credit. The approach retains that three equation model at its heart, but grafts on to it a financial sector that is, rather than a gross simplification, relatively rich in institutional detail. The motivation is that the model needs to be able to explain how changes in financial markets shifted and intensified risk in ways that ultimately precipitated the financial crisis and the subsequent macroeconomic turbulence.
It strikes me that this is an important project. Rather than leaving consideration of the impact of a highly developed financial system to more esoteric later study – if it is ever studied at all – it starts students off with an appreciation of the fundamental significance of finance for the functioning of the macroeconomy. [Read more...]