Thursday, July 28, 2016


A new essay "Macro-Finance," based on a talk I gave at the University of Melbourne this Spring. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes, and debt or institutional finance. I show how all these approaches produce quite similar results and mechanisms: the market's ability to bear risk varies over time, with business cycles. I speculate with some simple models that time-varying risk premiums can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, rather than Keynesian flow constraints or new-Keynesian intertemporal substitution.


  1. A brilliantly lucid and wonderfully crisp summary of the literature! Just one slight comment: Limited market participation models seem to have been missed out. For instance, Gust, Christopher, and David López-Salido. "Monetary policy and the equity premium."

  2. Hi John,

    I really enjoy reading your blog. Isn't the story you are trying to sell in the paper 'kind of' Keynesian? I understand it is not Keynesian in the way you define in the paper. However, higher risk aversion leads to higher precautionary savings, which in turn depresses aggregate demand (C & I). This sounds to me like a 'Keynesian' aggregate demand shortage story. I interpreted from your comments on Caballero, Gourinchas & Farhi that you were a bit skeptic about these aggregate demand shortage stories, and rather prefer productivity slowdown explanations for the crisis. Maybe I missunderstood. Has your view changed or are you exploring other possibilities?


    1. I think regulation-induced productivity slowdown is a good explanation for the years of agonizingly slow growth since 2009, but the sharp recession needs something else. "Keynesian" stories reflect some valuable intuition and observation, but need more solid economics, which I was trying to flesh out.

  3. Demand matters. Read up on Takahashi Korekiyo.

    The power of central banks is wonderful.

  4. Hi John.
    I think your survey is missing the fact that macroeconomists have put a lot of effort recently into integrating incomplete markets and precautionnary saving with standard macro models to endogenise shifts in aggregate Euler equations. see for example,

    If you're looking for mechanisms that transform reduction in desired consumption and private investment into declining output without nominal rigidity, I would also look into product market search frictions. Lower demand, reduces the efficiency of matching in product markets which like a productivity shock reduces output. This might seem to be hard to square with labour productivity dynamics in the US in 2008-2010, except that output is properly mismeasured in y/l by not fully incorporating intangible investment. I think this is the latest effort in that direction.

  5. John, please explain what I see as a conundrum. In several posts, you seem to take the position that the New Keynesian model is the de rigueur, go-to conceptualization for contemporary macro. As I think you explained that model in a very nice post a good while ago, that appears to be a two-sector model driven by an aggregate consumption function, to be manipulated by some government policy interventions through taxes, spending, bonds, and money. In that model, I didn't see any investment function or investment behaviors, and there was no financial sector (macro theory seems to be void of the notion that finance is anything but purely redistributive). Yet in your own informal comments on growth, investment, and employment, you have several times made a case for the negative effects of regulations and other distortions, lowering the expected rate of return to investments. And now, in your macro-finance piece, you seem to suggest that modern macro needs to gain a better understanding of the relationship between traditional, real based macro, and nominal wealth as determined in the financial sector. That seems to me to be fundamentally anti-Keynesian, as Keynesianism has developed since it got into the hands of Hicks and his ISLM, general equilibrium followers. In the General Theory, there are long chapters on the Merginal Efficiency of Investment, and on the speculative effects of the stock market, but none of that seems to have survived into modern macro. So, here's my conundrum: why are you still hyping the contemporary New Keynesian model that seems so inconsistent with your own policy proposals, your own expertise in finance, and so far removed from those same topics in the original Keynes? Isn't it just time to scrap modern Keynesianism altogether? Aren't we overdue for a complete paradigmatic shift in macro, to use the Kuhnian notion? Remember, Copernicus had the right concept, even though his math wasn't up to par, so the Ptolemaic system made more accurate predictions, until later astronomy got better. So, why not get the right model first, and worry about correlations later?


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.