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Ben Friedman: It is credit, not money, that matter

The recent Journal of Central Banking includes various papers from a 2011 Boston Fed Conference in honor of Ben Friedman. His closing remarks are well worth reading, as he delivers some rather critical comments to the profession. The first is the obsession with “money” when the crisis clearly showed that inside credit mattered most:

In retrospect, the economics profession’s focus on money—meaning
various subsets of instruments on the liability side of the banking
system’s balance sheet in contrast to bank assets, and correspondingly
the deposit assets on the public’s balance sheet in contrast
to the liabilities that the public issues—turns out to have been a
half-century-long diversion that did not serve our profession well.

But, accepting that credit matters, led him to question the key assumption of the representative agent:

If all agents were identical, there would of course be no reason for
any one of them to borrow from, or lend to, another. Hence turning
our focus toward credit, at the substantive level, also bears immediate
methodological implications. The resulting analysis needs to be
more subtle and, regrettably, more complicated than if what mattered
were simply money.

He concludes with some “big think” and notes that

I believe the time has now arrived for the
economics profession to examine how well our financial system is
doing its job and at what cost. I mentioned earlier that we need
some replacement for the full-rationality assumption as a disciplining
methodology for macroeconomic research, but that devising that
replacement will be difficult. I think there is a further reason, in addition
to the difficulty, behind economists’ reluctance to pursue this
path: fear that dropping the full-rationality assumption may turn
out to be subversive of the role of markets, and in particular the
financial markets, in our economy.

As he notes at the very end, there is plenty to do!

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