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Some thoughts on a recent piece by @MESandbu https://www.ft.com/content/5a92d0f1-e65f-4965-a685-bad83496e40f. First, the part I disagree with. Contrary to what argued in the article, multiple equilibria are deeply ingrained in mainstream macroeconomic thinking. Even in the very standard New Keynesian model,
which features both indeterminacy and steady state multiplicity, animal spirits matter.
That said, the article makes a relevant point when it argues that multiple equilibria are essentially ignored in the models used by central banks (though they do influence their actions, as
That said, the article makes a relevant point when it argues that multiple equilibria are essentially ignored in the models used by central banks (though they do influence their actions, as
Draghi’s whatever it takes taught us). Why is it so?
I see two main reasons. The first one is technical. Dealing with equilibrium multiplicity is relatively easy in theory, much less when it comes to the empirics. The silver lining is that there have been some interesting
I see two main reasons. The first one is technical. Dealing with equilibrium multiplicity is relatively easy in theory, much less when it comes to the empirics. The silver lining is that there have been some interesting
advances on this front (see work by @farmerrf or https://academic.oup.com/restud/article-abstract/85/1/87/3742166). Second, two trends in the global economy make multiple equilibria more relevant now than in the past. The first one is the fall in global interest rates. When interest rates are low, in fact, bubbles are
possible ( https://www.jstor.org/stable/1913232?seq=1, https://www.aeaweb.org/articles?id=10.1257/aer.102.6.3033). Moreover, the effective lower bound challenges the ability of monetary policy to stabilize aggregate demand, opening the door to fluctuations driven by animal spirits ( https://academic.oup.com/restud/article-abstract/85/3/1425/4587556,https://www.aeaweb.org/articles?id=10.1257/mac.20170367).
The second one is financial globalization. Free movement of capital across countries, by increasing the menu of assets among which investors can choose, increases the likelihood of sovereign debt crises driven by pessimistic animal spirits ( https://www.sciencedirect.com/science/article/abs/pii/0261560696000022,
https://www.jstor.org/stable/1811165?seq=1). Indeed, the high degree of financial integration caused by the introduction of the euro likely played a role in making the eurozone sovereign debt crisis possible ( https://crei.cat/wp-content/uploads/2020/07/MUFI.pdf).
Anyway, these considerations suggest that bridging the gap between macroeconomic theory and the frameworks used by policy institutions, especially by pushing forward the empirical analysis of models with multiple equilibria, is a crucial area for future research.
