Peter Diamond 3 defining events for macro 1970’s Build expectations Supply shocks Collapse of communism Importance of institutions Financial crisis Prevention Mitigation Property 1.Bubbles Now part of central banking aka financial stability goals 2. Consumer Protection Was legalistic – were documents accurate? CFBA set up to address this and incorporate behavioural factors 3. Mortgage modification Lehman response was speedy and admirable Europe’s response is dragging out the trouble Derivatives Fiendish Frankenstein monsters of financial engineering, says Paul Samueson Need a serious overhaul of collateral rules. At the moment, when things go awry, post more collateral. Collateral weakens financial situation. Creates death spiral. Financial Institutions Regulation to compensate for bank insurance. Bank insurance to .. New model: Dodd Frank: look for financial stability. Arrange credit flows for support of real economy. Anything that might interfere with financial stability is fair game, whatever their legal structure. Bank Regukation Monetary policy Inflation, unemployment Consumer Protection Legal + BEHAVIOURAL + BUBBLES Safety & Soundness of banks Financial stability Micropru regulation + Macro Pru regulation Deposit Insurance Financial institutions (risk scenarios, video not snapshot) Bank Runs (duration mismatch – is it right?) Externalities and incentives -> in general the market won’t get it right “There would be very large negative externalities associated with the disorderly failure of any SIFI [systematically important financial institution], distinct from the costs incurred by the firm and its stakeholders.” Tarullo, Fed. Pollution and congestion are standard examples Bubbles are human nature. Extrapolate. Simulations show bubbles again and again. Case and Schiller are the guys I look to on bubbles. Paul’s interpretation Automatic stabilisers are a pre-commitment. Very different from discretionary fiscal stimulus. Some of your colleagues are drawing parallels to the 1930s, and I mean not only the macroeconomy, but also current political process around discretionary fiscal policy. Austerity vs stimulus. How to treat discretionary policy in macro?