Working towards a stable and sustainable growth path - Centre For Macroeconomics ESRC Centres Transition Review

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Ten years after the onset of the financial crisis, the world still faces many macroeconomic challenges, such as increased inequality, low growth rates, low real interest rates, continued deleveraging, and a need for new regulation and policy tools to reduce the chance the world facing another economic crisis. The CFM brings together a diverse, but interconnected, set of institutions, which range from the policy making (Bank of England) through applied policy research (NIESR) to academia (LSE, University of Cambridge, University College London, and University of Oxford). This set of institutions creates a unique environment for imaginative, policy relevant, and intellectually robust research. Richer macroeconomic models capturing heterogeneity, inequality and endogenous business cycles.Recently, models and solution methods have been developed to study the interaction between heterogeneity and macroeconomic developments. A unifying theme in our research is the old Keynesian story of a recession being amplified by a downward spiral in which consumers who are facing uncertain job prospects and limited wealth to buffer negative income shocks prefer to hold on their money (precautionary savings) and firms who are facing uncertain demand for their products prefer not to hire. Recent empirical evidence has made clear that the observation of consumers sharply cutting back on consumption during bad and uncertain times is a much more important phenomenon than previously thought. In particular, it has been shown that there are many consumers who, although quite wealthy, cannot buffer unexpected negative shocks, because their wealth is in an illiquid form, namely houses. That is, there are also rich people who are financially constrained and act as 'hand-to-mouth' consumers. If there are more people who respond to negative developments by sharply reducing consumption increases because of imperfect insurance, then it is more important to incorporate this feature in business cycle models and not to rely on the representative agent paradigm, which relies on the assumption that consumers can perfectly self-insure.Richer macroeconomics with networks and interactions across sectors. The idea of network theory is to incorporate into economic models a good description of the actual network through which individuals and firms transact with each other. In such models, buyers (sellers) do not have free access to all sellers (buyers) in the economy, but only to a select number of (nearby) trading partners. The importance of such networks and the crucial role of some firms in such networks is understood in policy circles. For example, in the fall of 2008, the president of Ford Motor Co., Alan Mulally, requested government support for Ford's rivals General Motors and Chrysler. Survival of these competitors was important for Ford because their failures would result in the failures of their suppliers, which were essential for Ford being supplied with its necessary inputs.New policy tools for a new economic environment based on better macroeconomic models. The crisis has not only changed the way macroeconomists look at the world: it has also fundamentally changed economic policy. Monetary policies pursued during the financial crisis relied on new activities, such as quantitative easing (large scale interventions in particular financial markets) and forward guidance on future monetary policy decisions. These policies are still being pursued today and may become part of the standard set of monetary policy tools. Financial oversight has changed in terms of setting tougher standards and focusing on additional characteristics such as liquidity provision and leverage. Moreover, financial oversight has been extended to include macroprudential tools that consider the risks to the economy as a whole. At the CFM we use the new frameworks described above to consider policy tools in this new environment.