ABSTRACT
The Great Moderation in the past decade also marks the heyday of modern macroeconomics. It once seems that we know much about macroeconomics that Wicksell and Fisher did not and every shock to the economy can be well under control. However, the eruption of current financial crisis simply reminds us economists that there is actually a lot of macroeconomics that Wicksell and Fisher already knew but we have long forgotten. Although it is unfair to blame macroeconomists for not being able to forecast or prevent the financial crisis – just as we cannot attribute the crash of any aircraft to the failure of physics – there is still something extremely relevant to macro economy but systematically missing in modern macroeconomics. For long time macroeconomics and finance have been much isolated fields. Financial economists usually don’t look at the impact of financial market on macro economy, and macroeconomics models seldom have an explicit role for finance. Macroeconomics in practice, now often criticized for being incompetent for predicting, preventing, and handling the financial crises, is widely based on the dynamic stochastic general equilibrium (DSGE) framework which focuses on price and labor frictions and does not have any role for financial intermediaries and financial market. But the reality greatly differs from the world in the models. As is once more revealed in the crisis, the healthy financial market provides a lifeline for the non-financial firms to get funding, directing the resources in the economy to the place where they are best used, while the financial market in trouble freezes borrowing and lending, bringing the real economy into a nuclear winter.
