Working towards a stable and sustainable growth path - Centre For Macroeconomics ESRC Centres Transition Review

Ten years after the onset of the financial crisis, the world still faces many macroeconomic challenges, such as increased inequality, low growth rates, low real interest rates, continued deleveraging, and a need for new regulation and policy tools to reduce the chance the world facing another economic crisis.
The CFM brings together a diverse, but interconnected, set of institutions, which range from the policy making (Bank of England) through applied policy research (NIESR) to academia (LSE, University of Cambridge, University College London, and University of Oxford). This set of institutions creates a unique environment for imaginative, policy relevant, and intellectually robust research.

Richer macroeconomic models capturing heterogeneity, inequality and endogenous business cycles.

Recently, models and solution methods have been developed to study the interaction between heterogeneity and macroeconomic developments. A unifying theme in our research is the old Keynesian story of a recession being amplified by a downward spiral in which consumers who are facing uncertain job prospects and limited wealth to buffer negative income shocks prefer to hold on their money (precautionary savings) and firms who are facing uncertain demand for their products prefer not to hire. Recent empirical evidence has made clear that the observation of consumers sharply cutting back on consumption during bad and uncertain times is a much more important phenomenon than previously thought. In particular, it has been shown that there are many consumers who, although quite wealthy, cannot buffer unexpected negative shocks, because their wealth is in an illiquid form, namely houses. That is, there are also rich people who are financially constrained and act as 'hand-to-mouth' consumers. If there are more people who respond to negative developments by sharply reducing consumption increases because of imperfect insurance, then it is more important to incorporate this feature in business cycle models and not to rely on the representative agent paradigm, which relies on the assumption that consumers can perfectly self-insure.

Richer macroeconomics with networks and interactions across sectors.

The idea of network theory is to incorporate into economic models a good description of the actual network through which individuals and firms transact with each other. In such models, buyers (sellers) do not have free access to all sellers (buyers) in the economy, but only to a select number of (nearby) trading partners. The importance of such networks and the crucial role of some firms in such networks is understood in policy circles. For example, in the fall of 2008, the president of Ford Motor Co., Alan Mulally, requested government support for Ford's rivals General Motors and Chrysler. Survival of these competitors was important for Ford because their failures would result in the failures of their suppliers, which were essential for Ford being supplied with its necessary inputs.

New policy tools for a new economic environment based on better macroeconomic models.

The crisis has not only changed the way macroeconomists look at the world: it has also fundamentally changed economic policy. Monetary policies pursued during the financial crisis relied on new activities, such as quantitative easing (large scale interventions in particular financial markets) and forward guidance on future monetary policy decisions. These policies are still being pursued today and may become part of the standard set of monetary policy tools. Financial oversight has changed in terms of setting tougher standards and focusing on additional characteristics such as liquidity provision and leverage. Moreover, financial oversight has been extended to include macroprudential tools that consider the risks to the economy as a whole. At the CFM we use the new frameworks described above to consider policy tools in this new environment.

In the attached 'pathway-to-impact' document, we discuss in more detail our strategies to accomplish the impact we aim to achieve

- Policy-makers. Understanding macroeconomic developments is very difficult. Nevertheless, policy decisions have to be made and these often have far reaching consequences. This task is complicated further by the fact that the macroeconomic environment is changing over time, at times quite suddenly. It is therefore essential that policy-makers are provided with the best possible support. The CFM can help policy-makers in several ways. First, macroeconomics can help in understanding economic developments: for example, whether a current downturn is mainly cyclical or possibly long-lasting and whether the causes are mainly on the demand or supply side. Second, by building structural models, macroeconomists can evaluate alternative policies. This is especially important in the current environment as macroprudential policies are being considered. Such policies have never been in place so one cannot evaluate them by looking at past performance. Third, policy-makers benefit because of the interaction of their support staff with the centre. This link is, of course, very strong with the Bank of England because it is one of the branches of the CFM. But through visiting positions, conferences and joint research, there is interaction with other policy institutions as well. Finally, a lot of CFM members give direct advice to both politicians and government institutions in charge of economic policy.

- Students within and outside the CFM. By bringing together the researchers from several top UK universities, the Bank of England and NIESR, the CFM creates a unique environment in which students flourish. Students are exposed to a wide variety of skills and approaches. The policy dimension within the CFM makes them aware of the important questions that need answering. The summer courses, mini courses taught by CFM visitors and our teaching material website ensure that students outside the CFM also benefit from CFM activities. It is still the case that too many of our best students leave the UK to do a PhD in the US and often stay there after they graduate. As more students do this, it becomes more attractive to do so. The CFM can be an important force against this brain drain and ensure the presence of a sufficient supply of well-trained macroeconomists.

- Academic community at large. Most researchers build on the work of others. By producing high-quality research, the CFM aids other researchers. They are two reasons why this is especially true for CFM research. First, an important component of our research is the development of tools and making the associated software available. Second, the strong link with policy within the CFM is helpful in promoting policy-relevant research. The CFM also facilitates the direct interaction of academic research through CFM members visiting other institutions, academics visiting the CFM, joint work and conferences.

- Public at large. In democracies the people affect economic policies by voting - typically indirectly through general elections, but at times directly by referenda such as the Brexit referendum. Events such as Brexit but also economic policies such as austerity have important economic consequences and are likely to affect people differently. Thus, it is crucial that the public is well informed. During elections and referenda, people receive a lot of information from politicians and others who have a stake in the outcome. The CFM plays a very useful role in this process by providing balanced unbiased information. It is especially useful to know when the academic community does have reliable evidence on a particular subject and when it does not.