The University of Chicago

To construct and calibrate models for analyzing how the financial sector and its regulation can influence the macroeconomy

  • Amount $995,670
  • City Chicago, IL
  • Investigator Lars Hansen
  • Year 2011
  • Program Research
  • Sub-program Economic Institutions, Behavior, & Performance

The financial sector has traditionally played a minor role in macroeconomic models, typically acting only as a passive transmission mechanism for monetary transactions. Prior to 2008, this minor role seemed justified. Financial crises seemed to have only limited effects on the general economy, so an oversimplified portrayal of the financial sector did not seem unreasonable. After all, the Dow fell almost 23% on Black Monday, October 19, 1987, without triggering a recession. The negative effects of the turn-of-the-century dot-com bubble were mostly confined to Silicon Valley. So when the 2008 financial crisis resulted in a recession in the U.S. and elsewhere, many macroeconomists were at a loss. We are now acutely aware of the need for re-imagined macroeconomic models that take systematic financial risk into account, models that address how financial shocks can be transmitted to the wider economy and vice versa, and that help policy-makers identify and limit systematic risks. Such research has hardly begun, however, and economists are divided on how new models should be formulated. Funds from this grant will support the efforts of Lars Hansen of the University of Chicago and Andrew Lo of M.I.T to convene a working group of leading economists to explore, critique, and consolidate new approaches to modeling systemic financial risk and how the financial sector is connected to the broader economy.

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