Money and banking in a recent neo-classical model: an improvement?
In 2009 Willem Buiter stated (read the whole thing!):
Standard macroeconomic theory did not help foresee the crisis, nor has it helped understand it or craft solutions. This columns argues that both the New Classical and New Keynesian complete markets macroeconomic theories not only did not allow the key questions about insolvency and illiquidity to be answered. They did not allow such questions to be asked. A new paradigm is needed.
Has the situation improved?
An already often quoted recent New Classical/Keynesian (whatever) study which, in 2010, tried to address this situation is “Credit and banking in a DSGE model of the euro area ” (Don’t read the whole thing!) by Andrea Gerali, Stefano Neri, Luca Sessa and Federico Maria Signoretti, a working paper of the Banca d’Italia.
What do we read, aside from no less than sixteen so-called ‘callibrated’, i.e. cherry picked ad hoc values for critical parameters of the model?
A. “Banks issue collateralized loans to both households and firms, obtain funding via deposits“.
This means that MFI’s (Monetary financial Institutions i.e. money creating banks) and endogenous money creation, part and parcel of our economy (as shown by the monetary statistics of the ECB), are not included in the study. The MFI’s are the most important banks and the very organizations which issue all the new M-3 money and in the same process provide the majority of mortgages (as shown by the monetary statistics of the ECB).
B. “In addition, households face a borrowing constraint: the expected value of their collateralizable housing stock at period t must be high enough to guarantee lenders of debt repayment… mIt is the (stochastic) loan-to-value ratio (LTV) for mortgages…At a macro-level, the value of mIt determines the amount of credit that banks make available to households, for a given (discounted) value of their housing stock. We assume that variations of LTV ratios do not depend on individual bank choices: rather, we model LTV ratios as exogenous stochastic processes” (emphasis added).
This means that banks do not create money and do not engage in reckless lending. Together, these assumptions rule out any active role of banks in for instance housing bubbles and keep the idea of the rational, Maximize U from here to eternity sector households intact. In fact – they even rule out housing bubbles as we know them.
Key questions still can not be asked.
P.S. Isn’t modern physics all about the estimation of the precise value of critical parameters, like the mass of this Higgs-thing?