the future of macroeconomics macro theory and models at the bank of england abstract the adoption as policy models by central banks of representative agent new keynesian dynamic stochastic general equilibrium models has been widely criticised including for their simplistic micro foundations at the bank of england the previous generation of policy models is seen in its 1999 medium term macro model mtmm instead of improving that model to correct its considerable flaws many shared by other non dsge policy models such as the federal reserve s frb us it was replaced in 2004 by the dsge based beqm though this clearly failed during and after the global financial crisis it was replaced in 2011 by the dsge compass complemented by a suite of models we provide a general critique of dsge models for explaining forecasting and policy analyses at central banks and suggest new directions for improving current empirical macroeconomic models based on empirical modelling broadly consistent with better theory rather than seeking to impose simplistic and unrealistic theory

global macroeconomic cooperation in response to the covid 19 pandemic a roadmap for the g20 and the imf the covid 19 crisis has caused the greatest collapse in global economic activity since 1720 some advanced countries have mounted a massive fiscal response both to pay for disease fighting action and to preserve the incomes of firms and workers until the economic recovery is under way but there are many emerging market economies which have been prevented from doing what is needed by their high existing levels of public debt and especially by the external financial constraints which they face we argue in the present paper that there is a need for international cooperation to allow such countries to undertake the kind of massive fiscal response that all countries now need and that many advanced countries have been able to carry out we show what such cooperation would involve we use a global macroeconomic model to explore how extraordinarily beneficial such cooperation would be simulations of the model suggest that gdp in the countries in which extra fiscal support takes place would be around two and a half per cent higher in the first year and that gdp in other countries in the world be more than one per cent higher so far such cooperation has been notably lacking in striking contrast with what happened in the wake of the global financial crisis in 2008 the necessary cooperation needs to be led by the group of twenty g20 just as happened in 2008 9 since the g20 brings together the leaders of the world s largest economies this cooperation must also necessarily involve a promise of international financial support from the international monetary fund otherwise international financial markets might take fright at the large budget deficits and current account deficits which will emerge creating fiscal crises and currency crises and so causing such expansionary policies which we advocate to be brought to an end

macroeconomics after the crisis time to deal with the pretense of knowledge syndrome the recent financial crisis has damaged the reputation of macroeconomics largely for its inability to predict the impending financial and economic crisis to be honest this inability to predict does not concern me much it is almost tautological that severe crises are essentially unpredictable for otherwise they would not cause such a high degree of distress what does concern me about my discipline is that its current core by which i mainly mean the so called dynamic stochastic general equilibrium approach has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one this is dangerous for both methodological and policy reasons to be fair to our field an enormous amount of work at the intersection of macroeconomics and corporate finance has been chasing many of the issues that played a central role during the current crisis including liquidity evaporation collateral shortages bubbles crises panics fire sales risk shifting contagion and the like however much of this literature belongs to the periphery of macroeconomics rather than to its core i will discuss the distinction between the core and the periphery of macroeconomics as well as the futile nature of the integrationist movement that is the process of gradually bringing the insights of the periphery into the dynamic stochastic general equilibrium structure i argue that the complexity of macroeconomic interactions limits the knowledge we can ever attain and that we need to place this fact at the center of our analysis we should consider what this complexity does to the actions and reactions of the economic agent and seek analytical tools and macroeconomic policies that are robust to the enormous uncertainty to which we are confined

relational contracts and the theory of the firm relational contracts informal agreements sustained by the value of future relationships are prevalent within and between firms we develop repeated game models showing why and how relational contracts within firms vertical integration differ from those between nonintegration we show that integration affects the parties temptations to renege on a given relational contract and hence affects the best relational contract the parties can sustain in this sense the integration decision can be an instrument in the service of the parties relationship our approach also has implications for joint ventures alliances and networks and for the role of management within and between firms

anomalies in intertemporal choice evidence and an interpretation research on decision making under uncertainly has been strongly influenced by the documentation of numerous expected utility eu anomalies behaviors that violate the expected utility axioms the relative lack of progress on the closely related topic of intertemporal choice is partly due to the absence of an analogous set of discounted utility du anomalies we enumerate a set of du anomalies analogous to the eu anomalies and propose a model that accounts for the anomalies as well as other intertemporal choice phenomena incompatible with du we discuss implications for savings behavior estimation of discount rates and choice framing effects

macroeconomic policy design and control theory a failed partnership my subject is the applicability of control theory to the pressing questions of macroeconomic policy design that face us both domestically and in the international arena i approach the issue with some trepidation conscious that i am a relative amateur in control matters i am also mindful of the dangers of claiming too much in the field of policy design those were nicely stated in a broader context by that eminent biologist sir peter medawar i984 when he wrote

discounting under uncertainty suppose asset pricing is governed by the capm or the icapm and the expected one period simple returns on the net cash flows of investment projects are constant through time then the net cash flows are priced by discounting their expected values with their expected one period simple returns but when net cash flows are priced by discounting their expected values with constant capm or icapm expected one period simple returns distributions of net cash flows more than one period ahead are likely to be skewed right expected payoffs are then larger than median pay offs and expected pay offs are progressively more unusual outcomes for longer investment horizons copyright 1996 by university of chicago press

the macroeconomic effects of fiscal policy linking an econometric model with theory in this paper the authors outline a method termed theoretical reconstruction which allows the system properties of any econometric macromodel to be related to a simpler theoretical model first elements of the econometric model which involve significant additional theoretical complexity compared to the theory model are removed this process continues until the properties of the deconstructed econometric model match those of the reference theory second the econometric model is gradually reconstructed noting at each point how each element of additional complexity influences the model properties the technique is illustrated using fiscal policy changes and the u k econometric model compact coauthors are julia darby jonathan ireland and ottavio ricchi

reconciling sustainability systems theory and discounting abstract most definitions of sustainability imply that a system is to be maintained at a certain level held within certain limits into the indefinite future sustainability denies run away growth but it also avoids any decline or destruction this sustainability path is hard to reconcile with the renewal cycle that can be observed in many natural systems developing according to their intrinsic mechanisms and in social systems responding to internal and external pressures systems are parts of hierarchies where systems of higher levels are made up of subsystems from lower levels renewal in components is an important factor of adaptation and evolution if a system is sustained for too long it borrows from the sustainability of a supersystem and rests upon lack of sustainability in subsystems therefore by sustaining certain systems beyond their renewal cycle we decrease the sustainability of larger higher level systems for example schumpeter s theory of creative destruction posits that in a capitalist economy the collapse and renewal of firms and industries is necessary to sustain the vitality of the larger economic system however if the capitalist economic system relies on endless growth then sustaining it for too long will inevitably borrow from the sustainability of the global ecosystem this could prove catastrophic for humans and other species to reconcile sustainability with hierarchy theory we must decide which hierarchical level in a system we want to sustain indefinitely and accept that lower level subsystems must have shorter life spans in economic analysis inter temporal discount rates essentially tell us how long we should care about sustaining any given system economists distinguish between discount rates for individuals based on personal time preference lower discount rates for firms based on the opportunity cost of capital and even lower discount rates for society for issues affecting even higher level systems such as global climate change many economists question the suitability of discounting future values at all we argue that to reconcile sustainability with inter temporal discounting discount rates should be determined by the hierarchical level of the system being analyzed

modelling a complex world improving macro models macro models have come under criticism for their ability to understand or predict major economic events such as the global financial crisis and its aftermath some of that criticism is warranted but in our view much is not this paper contributes to the debate over the adequacy of benchmark dsge models by showing how three extensions which are features that have characterized the global economy since the early 2000s are necessary to improve our understanding of global shocks and policy insights the three extensions are to acknowledge and model the entire global economy and the linkage through trade and capital flows to allow for a wider range of relative price variability by moving to multiple sector models rather than a single good model and to allow for changes in risk perceptions which propagate through financial markets and adjustments in the real economy these extensions add some complexity to large scale macromodels but without them policy models can oversimplify things allowing misinterpretations of shocks and therefore costly policy mistakes to occur using oversimplified models to explain a complex world makes it more likely there will be puzzles the usefulness of these extensions is demonstrated in two ways first by briefly revisiting some historical shocks to show how outcomes can be interpreted that make sense within a more complex dsge framework then by making a contemporary assessment of the implications from the proposed large fiscal stimulus and the bans on immigration by the trump administration which have both sectoral and macroeconomic implications that interact

the opportunity criterion consumer sovereignty without the assumption of coherent preferences this paper proposes a formulation of consumer sovereignty for use in normative economics which does not presuppose individuals preferences to be coherent the fundamental intuition that opportunity and responsibility have moral value is formalised as a responsibility criterion for assessing opportunities in an economic system a model of an exchange economy is presented in which rational arbitrageurs compete to make profits by trading with non rational consumers in equilibrium this economy satisfies the responsibility criterion one interpretation of this result is that in a competitive environment the overall effects of money pumps are benign even if individuals preferences are persistently incoherent

beyond portfolio theory the next frontier logically investment theory s next frontier is to put into practice the rich set of tools that academia has bestowed on the investment community starting with harry markowitz s seminal article on portfolio selection in 1952 or is it in fact the next frontier lies beyond simply engineering the implementation of new investment decision tools the time has come to integrate the powerful insights offered by information theory and principal agent theory into a holistic comprehensive theory of investing only such an expanded theory offers any material hope of improving the economic prospects of the millions of clients beneficiaries of today s mutual funds pension funds endowments and foundations

structural reforms animal spirits and monetary policies abstract we use a new keynesian behavioral macroeconomic model to analyze how structural reforms affect the economy there are two types of structural reforms the first one increases price flexibility the second one increases competition in the labor market and raises potential output we find that in a rigid economy business cycle movements are dominated by movements of animal spirits increasing price flexibility reduces the power of animal spirits and the boom bust nature of the business cycle we study the trade offs between output and inflation volatility faced by the central bank we find that flexibility improves these trade offs making it easier for the central bank to stabilize output and inflation

cost of capital discounting and relational contracting endogenous optimal return and duration for joint investment projects concession project financing and public private partnership schemes are investment projects that are generally submitted to valuation criteria based on discounted cash flow analysis the theoretical basis of these valuation criteria are now at issue pursuant to recent advances in relational contracting economics and behavioural finance joint investment projects can be considered as special relational environments where the project s returns improve on alternative replacement opportunities this article seeks to bridge the gap between new theories and widely used valuation techniques by providing a generalized approach to investment valuation this article suggests reasonable valuation criteria that fit these new theoretical developments including an endogenous optimal duration function that may be integrated into the project s contractual agreement

contracting on time the paper shows how the time considerations especially those concerning contract duration affect incomplete contract theory time is not only a dimension along which the relationship unfolds but also a continuous verifiable variable that can be included in contracts we consider a bilateral trade setting where contracting investment trade and renegotiation take place in continuous time we show that efficient investment can be induced either through a sequence of constantly renegotiated fixed term contracts or through a renegotiation proof evergreen contract a perpetual contract that allows unilateral termination with advance notice we provide a detailed analysis of properties of optimal contracts

the pension problem on demographic time bombs and odious debt much has been written recently particularly after 2000 2002 left pensions in tatters about the challenge of meeting pension obligations the challenge discussed here is interesting and multifaceted embracing issues of demographics reasonable expectations business ethics stakeholder interests the social compact and intergenerational equity the first step is to acknowledge the reality that assuming investments will earn a risk premium without acknowledging the risk that they will not deliver a premium disguises the real size of pension liabilities

gender differences in risk aversion and expected retirement benefits women are generally considered more risk averse than men controlling for age income and education this study examined the impact of gender on the superannuation retirement fund risk preferences of staff in the australian university sector the findings suggest that women choose more conservative investment strategies than men and that lower income which affects the amount members contribute to their superannuation funds is the primary contributor to the lower projected retirement benefits of women providing members with a choice among risk levels in their retirement investments should significantly benefit male and female retirees

ending the microfoundations hegemony the new classical counter revolution changed macromodelling methodology and ushered in the hegemony of microfounded models yet in reality at any particular point in time there is a trade off between data coherence and theoretical coherence and insisting that all academically respectable modelling should be at one extreme of this trade off is a major mistake the paper argues that if more traditional structural econometric models sems had been developed alongside microfounded models links between finance and the real economy would have been more thoroughly explored before the financial crisis allowing macroeconomists to respond better to the great recession just as microfoundations hegemony held back macroeconomics on that occasion it is likely to do so again macroeconomics will develop more rapidly in useful directions if microfounded models and more traditional sems work alongside each other and are accorded equal academic respect

bringing the market inside the firm academics consultants and practitioners have long advocated bringing the market inside the firm for example in the 1950 s and 1960 s economists proposed that the transferpricing problem should be solved by charging market prices for internal transactions similarly in the 1980 s financial economists suggested that the capital allocation problem should be solved by charging the external cost of capital for internal investments and wave after wave of organizational restructuring has advocated radical decentralization empowerment intrapreneurship and the like in short making employees feel like owners proponents of making transactions within firms more market like often seem to ignore the factors that brought these transactions inside firms in the first place but bengt holmstrom and paul milgrom 1991 1994 holmstrom and jean tirole 1991 and holmstrom 1999 hereafter referred to collectively as hmt remind us that in some cases integration is efficient precisely because it eliminates market incentives in such cases bringing the market inside the firm would clearly be undesirable in this paper we show that bringing the market inside the firm is often not feasible even if it would be desirable more precisely if some aspects of the market transaction are noncontractible as we define below then it is impossible to replicate spot market payoffs inside a firm this result would be trivial if the firm s only instruments were court enforceable contracts it is impossible by definition for such contracts to replicate payoffs that were noncontractible in a spot market our contribution is to show that this result also applies to relational contracts i e self enforcing agreements in repeated games to establish this result we follow sanford grossman and oliver hart 1986 hart and john moore 1990 and hart 1995 hereafter referred to collectively as ghm in using asset ownership to determine whether a particular transaction is inside a firm and hmt in adding court enforceable contracts to asset ownership models we also draw on our own work baker et al 2001 to model relational contracts the resulting model is the first we know of that simultaneously analyzes asset ownership courtenforceable contracts and relational contracts