FRC Call for Papers 2015 #2:

“The financial cycle and macroeconomics: What have we learnt?”

One of the world’s most provocative and interesting monetary economists of our times published in December 2012 an working paper on the financial cycle with strong heterodox inclinations. He is Claudio Borio, Head of the Monetary and Economic Department at the Bank for International Settlements. The paper, titled “The financial cycle and macroeconomics: What have we learnt?” generated substantial debate and was published in the Journal of Banking & Finance in August 2014.

The paper aims at reintroducing the financial cycle as a crucial element in macroeconomic analysis and policy making. The present call for papers aims at generating a debate around Borio’s paper and contribute to the progress of scientific thinking in the domain of financial fluctuations and their implications in terms of policymaking. For each section of the paper we will propose a set of questions to set the balls rolling.

First, Borio defines empirically the notion of financial cycle, a concept that fell out favor in post war mainstream. We invite perspective authors to ponder on what are the causes of the financial cycle. Is the interplay between financial cycle and business cycle the right place to set the stage for a paradigm shift? Does it make sense to define the financial cycle with the methodology chosen by the author? Is the financial cycle measurable in order to build reliable early warning indicators?

In the second section Borio evaluates the major analytical challenges for the prevailing paradigms in introducing the notion of financial cycle. How many of the challenges identified by Borio can find a partial answer in heterodox traditions? To which extent existing heterodox traditions present a solid empirical foundations to support operational use? The capability to identify unsustainable path of the economy while inflation is low is a complex task. Are heterodox traditions able to cope with it? Does Borio identify all the challenges faced by the current models?

The author provides as well preliminary recommendations on how to overcome these challenges. What is the state of the art in heterodox economics introducing heterogeneous and incomplete knowledge (coping with fundamental uncertainty) in the models? What are the challenges in introducing dynamic risk appetite into the modeling? What are the limitations moving the approach toward disequilibrium analysis? Can the recommendations proposed  by the author be implemented with quantitative modeling techniques?

The final section, Borio deals with the policy implications of his proposed paradigm change. In times of booms, how can we assess whether the economy and the financial markets are on a sustainable path? What is the role of inflation in this assessment? Are anticyclical measures the only possible option for macroprudential regulation? Operationally speaking, how easy is the implementation of alternative policies? What are the possible unintended consequences hidden under Borio’s policy proposals in terms of macroprudential, monetary and fiscal policies?

Note that, when dealing with a crisis, Borio suggests to diagnose whether we are facing a “balance sheet crisis”. Is this a new theory or just a new name for old roots? The author also distinguishes two different phases: crisis management and crisis resolution. What is the theoretical foundation for these phases, and what policies should be recommended? Any empirical survey about relevant historical episodes in this respect would be highly valuable.

The editors welcome thought provoking papers. We encourage submission of theoretic or applied research, critical reviews, surveys, and empirical studies.