Mainstream macroeconomics has been quite heavily criticized for failing to predict the recent financial crisis and its extremely adverse macroeconomic effects, amounting to a global economic recession. The field has also been accused of not providing proper tools and guidance to policymakers to manage the crisis and steer economies out of recession.
Such criticism is of course understandable and, at least to an extent, justified. The debate among economists has often been a politico-philosophical debate between different schools of thought about the root cause of the crisis, the best approach to modelling it and the appropriate or optimal policy response by governments and central banks.
Central banks have received a fair share of criticism from well-known academics. Ever since the global economy was hit hard after the collapse of Lehman Brothers in September 2008, central banks have been criticized for not paying due attention in either their analytical or their policy work to the possibility of a financial crisis per se, or of financial instabilities with potentially highly adverse effects on macroeconomic activity.
Policy measures taken by central banks have also been criticized, but to a lesser extent. It is well known that many of the business cycle models developed in central banks all over the world for forecasting, simulation and research purposes are deeply rooted in mainstream macroeconomics based on dynamic general equilibrium modelling.
The crisis notwithstanding, it is of course crucial to have a solid understanding of the interactions between business cycle fluctuations and financial factors, including financial crises. To this end, mainstream business cycle research faces an interesting and challenging research agenda.
This does not, however, imply that all that has been achieved during the past 25 years should be forgotten and that business cycle research should start from a clean table. Many of the mainstream business cycle models have been developed to quantitatively account for the main time series properties of the key macroeconomic variables under normal business cycle conditions. On balance, this research on quantitative business cycle modelling has been successful. Furthermore, the modelling discipline imposed on business cycle research by dynamic general equilibrium modelling must, in the end, be viewed as a welcome element which greatly contributes to the comparability of both research and models of business cycle fluctuations.
What lies ahead, then, is to extend these models to incorporate important insights and findings from current frontline financial market research. This will clearly involve deep theorizing.
It is important for central banks to remain fully informed of the advances and breakthroughs that will potentially emerge from future research on business cycle fluctuations. The fact that central banks are active agents in using and building (mainstream) business cycle models contributes to the possibility that modelling innovations will emerge and at least partly ensures that relevant innovations generated outside central bank research will be taken aboard.
All this implies that central banks have to remain open to academic influence. High-frequency interaction between central banks and academia is important, but so is having central bank research functions externally evaluated by the academic community on a more or less regular basis.
To this end, the Bank of Finland has been a forerunner among central banks, as in December 2009 it published its third evaluation report of its research function. This was conducted by three internationally renowned academic professors: Anil Kashyap (University of Chicago, Booth School of Business), Matti Pohjola (Helsinki School of Economics) and Volker Wieland (Goethe University of Frankfurt).
The report makes a number of useful suggestions on how to improve the Bank's research function further. It also provides valuable input for concrete measures to improve the quality of the Bank's research and for ensuring that research focus and priorities are in line with those set by the Board of the Bank of Finland. All in all, the external evaluation process is a very useful tool for the Bank to reflect upon its research function. |