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The policy response to this challenge has included important successes, most notably the concerted international effort to stabilize the global financial system after the crisis reached its worst point in the fall of For its part, the Federal Reserve worked closely with other policymakers, both domestically and internationally, to help develop the collective response to the crisis, and it played a key role in that response by providing backstop liquidity to a range of financial institutions as needed to stem the panic.

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The Fed also developed special lending facilities that helped to restore normal functioning to critical financial markets, including the commercial paper market and the market for asset-backed securities; led the bank stress tests in the spring of that significantly improved confidence in the U. Despite these and other policy successes, the episode as a whole has not been kind to the reputation of economic and economists, and understandably so. Almost universally, economists failed to predict the nature, timing, or severity of the crisis; and those few who issued early warnings generally identified only isolated weaknesses in the system, not anything approaching the full set of complex linkages and mechanisms that amplified the initial shocks and ultimately resulted in a devastating global crisis and recession.

Moreover, although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment. As a result of these developments, some observers have suggested the need for an overhaul of economics as a discipline, arguing that much of the research in macroeconomics and finance in recent decades has been of little value or even counterproductive. Although economists have much to learn from this crisis, as I will discuss, I think that calls for a radical reworking of the field go too far.

In particular, it seems to me that current critiques of economics sometimes conflate three overlapping yet separate enterprises, which, for the purposes of my remarks today, I will call economic science, economic engineering, and economic management. Economic science concerns itself primarily with theoretical and empirical generalizations about the behavior of individuals, institutions, markets, and national economies.

Most academic research falls in this category. Economic engineering is about the design and analysis of frameworks for achieving specific economic objectives. Examples of such frameworks are the risk-management systems of financial institutions and the financial regulatory systems of the United States and other countries. Economic management involves the operation of economic frameworks in real time--for example, in the private sector, the management of complex financial institutions or, in the public sector, the day-to-day supervision of those institutions.

As you may have already guessed, my terminology is intended to invoke a loose analogy with science and engineering.

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Underpinning any practical scientific or engineering endeavor, such as a moon shot, a heart transplant, or the construction of a skyscraper are: first, fundamental scientific knowledge; second, principles of design and engineering, derived from experience and the application of fundamental knowledge; and third, the management of the particular endeavor, often including the coordination of the efforts of many people in a complex enterprise while dealing with myriad uncertainties.

Success in any practical undertaking requires all three components. For example, the fight to control AIDS requires scientific knowledge about the causes and mechanisms of the disease the scientific component , the development of medical technologies and public health strategies the engineering applications , and the implementation of those technologies and strategies in specific communities and for individual patients the management aspect.

Twenty years ago, AIDS mortality rates mostly reflected gaps in scientific understanding and in the design of drugs and treatment technologies; today, the problem is more likely to be a lack of funding or trained personnel to carry out programs or to apply treatments. With that taxonomy in hand, I would argue that the recent financial crisis was more a failure of economic engineering and economic management than of what I have called economic science.

The economic engineering problems were reflected in a number of structural weaknesses in our financial system. In the private sector, these weaknesses included inadequate risk-measurement and risk-management systems at many financial firms as well as shortcomings in some firms' business models, such as overreliance on unstable short-term funding and excessive leverage. In the public sector, gaps and blind spots in the financial regulatory structures of the United States and most other countries proved particularly damaging.

These regulatory structures were designed for earlier eras and did not adequately adapt to rapid change and innovation in the financial sector, such as the increasing financial intermediation taking place outside of regulated depository institutions through the so-called shadow banking system.

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In the realm of economic management, the leaders of financial firms, market participants, and government policymakers either did not recognize important structural problems and emerging risks or, when they identified them, did not respond sufficiently quickly or forcefully to address them. Shortcomings of what I have called economic science, in contrast, were for the most part less central to the crisis; indeed, although the great majority of economists did not foresee the near-collapse of the financial system, economic analysis has proven and will continue to prove critical in understanding the crisis, in developing policies to contain it, and in designing longer-term solutions to prevent its recurrence.

I don't want to push this analogy too far. Economics as a discipline differs in important ways from science and engineering; the latter, dealing as they do with inanimate objects rather than willful human beings, can often be far more precise in their predictions. Also, the distinction between economic science and economic engineering can be less sharp than my analogy may suggest, as much economic research has direct policy implications. And although I don't think the crisis by any means requires us to rethink economics and finance from the ground up, it did reveal important shortcomings in our understanding of certain aspects of the interaction of financial markets, institutions, and the economy as a whole, as I will discuss.

Certainly, the crisis should lead--indeed, it is already leading--to a greater focus on research related to financial instability and its implications for the broader economy. In the remainder of my remarks, I will focus on the implications of the crisis for what I have been calling economic science, that is, basic economic research and analysis. I will first provide a few examples of how economic principles and economic research, rather than having misled us, have significantly enhanced our understanding of the crisis and are informing the regulatory response.

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However, the crisis did reveal some gaps in economists' knowledge that should be remedied. I will discuss some of these gaps and suggest possible directions for future research that could ultimately help us achieve greater financial and macroeconomic stability. How Economics Helped Us Understand and Respond to the Crisis The financial crisis represented an enormously complex set of interactions--indeed, a discussion of the triggers that touched off the crisis and the vulnerabilities in the financial system and in financial regulation that allowed the crisis to have such devastating effects could more than fill my time this afternoon.

But, at least in retrospect, economic principles and research were quite useful for understanding key aspects of the crisis and for designing appropriate policy responses. For example, the excessive dependence of some financial firms on unstable short-term funding led to runs on key institutions, with highly adverse implications for the functioning of the system as a whole. The fact that dependence on unstable short-term funding could lead to runs is hardly news to economists; it has been a central issue in monetary economics since Henry Thornton and Walter Bagehot wrote about the question in the 19th century.

Prior to the crisis, these institutions had become increasingly dependent on various forms of short-term wholesale funding, as had some globally active commercial banks. Examples of such funding include commercial paper, repurchase agreements repos , and securities lending. In the years immediately before the crisis, some of these forms of funding grew especially rapidly; for example, repo liabilities of U.

In the historically familiar bank run during the era before deposit insurance, retail depositors who heard rumors about the health of their bank--whether true or untrue--would line up to withdraw their funds. If the run continued, then, absent intervention by the central bank or some other provider of liquidity, the bank would run out of the cash necessary to pay off depositors and then fail as a result. Often, the panic would spread as other banks with similar characteristics to, or having a financial relationship with, the one that had failed came under suspicion. In the recent crisis, money market mutual funds and their investors, as well as other providers of short-term funding, were the economic equivalent of earlys retail depositors.

Shadow banks relied on these providers to fund longer-term credit instruments, including securities backed by subprime mortgages. After house prices began to decline, concerns began to build about the quality of subprime mortgage loans and, consequently, about the quality of the securities into which these and other forms of credit had been packaged. Although many shadow banks had limited exposure to subprime loans and other questionable credits, the complexity of the securities involved and the opaqueness of many of the financial arrangements made it difficult for investors to distinguish relative risks.

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In an environment of heightened uncertainty, many investors concluded that simply withdrawing funds was the easier and more prudent alternative. In turn, financial institutions, knowing the risks posed by a run, began to hoard cash, which dried up liquidity and significantly limited their willingness to extend new credit.

Because the runs on the shadow banking system occurred in a historically unfamiliar context, outside the commercial banking system, both the private sector and the regulators insufficiently anticipated the risk that such runs might occur. However, once the threat became apparent, two centuries of economic thinking on runs and panics were available to inform the diagnosis and the policy response.

In particular, in the recent episode, central banks around the world followed the dictum set forth by Bagehot in To avert or contain panics, central banks should lend freely to solvent institutions, against good collateral. Invoking emergency powers not used since the s, the Federal Reserve also found ways to provide liquidity to critical parts of the shadow banking system, including securities dealers, the commercial paper market, money market mutual funds, and the asset-backed securities market.

For today's purposes, my point is not to review this history but instead to point out that, in its policy response, the Fed was relying on well-developed economic ideas that have deep historical roots. Rather, the problem was the failure of both private- and public-sector actors to recognize the potential for runs in an institutional context quite different than the circumstances that had given rise to such events in the past. These failures in turn were partly the result of a regulatory structure that had not adapted adequately to the rise of shadow banking and that placed insufficient emphasis on the detection of systemic risks, as opposed to risks to individual institutions and markets.

Economic research and analysis have proved useful in understanding many other aspects of the crisis as well. For example, one of the most important developments in economics over recent decades has been the flowering of information economics, which studies how incomplete information or differences in information among economic agents affect market outcomes. Because the agent typically has more information than the principal--managers tend to know more about the firm's opportunities and problems than do the shareholders, for example--and because the financial interests of the principal and the agent are not perfectly aligned, much depends on the contract whether explicit or implicit between the principal and the agent, and, in particular, on the incentives that the contract provides the agent.

Poorly structured incentives were pervasive in the crisis. For example, compensation practices at financial institutions, which often tied bonuses to short-term results and made insufficient adjustments for risk, contributed to an environment in which both top managers and lower-level employees, such as traders and loan officers, took excessive risks. Serious problems with the structure of incentives also emerged in the application of the so-called originate-to-distribute model to subprime mortgages.

To satisfy the strong demand for securitized products, both mortgage lenders and those who packaged the loans for sale to investors were compensated primarily on the quantity of "product" they moved through the system. As a result, they paid less attention to credit quality and many loans were made without sufficient documentation or care in underwriting.

Conflicts of interest at credit agencies, which were supposed to serve investors but had incentives to help issuers of securities obtain high credit ratings, are another example. Consistent with key aspects of research in information economics, the public policy responses to these problems have focused on improving market participants' incentives.

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  4. For example, to address problems with compensation practices, the Federal Reserve, in conjunction with other supervisory agencies, has subjected compensation practices of banking institutions to supervisory review. The analysis provides empirical evidence that could help economists decide whether these modern digital currencies are trust-based but intrinsically worthless like the "fiat" paper money system of familiar currencies we use or the new "gold standard".

    The research team offers details of their analysis and their conclusions in the International Journal of Monetary Economics and Finance [ Editor Prof. Bruno S. About this journal Editorial board Submitting articles.

    Intl Econ - Chapter 01: International Economy & Globalization

    Topics covered include International financial institutions Monetary theory Exchange rates and interest rates Bank services and development Central banking International banking Credit and financial markets Open economy macroeconomics Macroeconometrics International finance Financial markets and institutions Corporate governance Financial liberalisation Financial performance Credit channels More on this journal Readership IJMEF provides a scientific vehicle for researchers, policy makers, national and corporate treasuries, central and investment banks, international organisations, and academic institutions.

    Contents IJMEF invites and welcomes theoretical and applied papers, case studies, and special issues. Browse issues Vol. More on permissions. Editor Sergi , Bruno S. We concentrate on statistical distribution theory and statistical inference before applying these concepts to the study of the linear regression model, whose extensions will be analysed in detail in subsequent econometrics modules. The second half introduces the statistical methods and concepts most applicable in economics. The analysis of economic data necessarily proceeds in an environment where there is uncertainty about the processes that generated the data.

    Statistical methods provide a framework for understanding and characterising this uncertainty.

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    These concepts are most conveniently introduced through the analysis of single-variable problems. However, economists are most often concerned about relationships among variables.

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    The module builds towards the study of regression analysis, which is often applied by economists in studying such relationships. The first half of the module provides an introduction to the mathematical methods required for economic modelling, focusing on. This module focuses on a range of current issues facing the world economy, seeks to illustrate how economists model such issues, and examines potential policy responses. Example topics to be covered are:. This module is intended as a foundation for the understanding of modern economic theories and policies. It is concerned with the:. As will be discovered, the 21st century Western views of everyday economic concepts such as ownership, money, exchange, work, poverty, industrialisation, economic growth and government are quite different from those expressed at other times and in other places. In this module we will explore the long-run, historical determinants of the wealth of nations. We will begin by taking a long-run view on modern economic growth, showing how this has led to dramatic changes in the relative wealth of nations over the last years.

    We will then ask two key questions: why have modern economic growth started in some places rather than others? And while have some countries been able to catch up, while others have not? These investigations will improve our understanding of why are some countries much richer than others, and will give us some important insights on how to promote sustained growth in developing countries. The module draws on a vibrant new literature in economics that looks at comparative development as the outcome of a long historical process, and uses techniques originally developed in economics to improve our understanding of history.