Who Leads the Change in Macro-Prudential Thinking?

Matthias Thiemann

What is the role of applied economists working in central banks and international organizations? And what is the role of academic economists contributing to the resolution of the problems that applied economists face?

This project analyses the rise of macro-prudential research to answer these questions. We aim to better understand the changes to economic thinking about finance post-crisis and the role of applied economists in central banks and international organizations.

Since the Global Financial Crisis, new macro-prudential frameworks have been introduced at many central banks. Underpinning these frameworks is the view that finance is inherently unstable, that there are financial cycles and that financial excesses can damage real economic activity. These views stand in stark contrast to the pre-crisis vision, based on the Efficient Market Hypothesis and the Rational Expectations framework, which was used to advocate a structural deregulation of finance. Some central banks with responsibility for financial system stability had either downsized or downgraded their financial stability departments.

In this context, it was perhaps inevitable that there would be no substantial change in macro-prudential regulation in the immediate aftermath of the crisis. Yet, extraordinary emergency measures were eventually used in many countries. Some had attributed this delay to a lack of new thinking (Muegge, 2013). At the same time, they noted that the academic system tended to reinforce old models and methods. Mirowski (2013) argued that institutionalized efforts to rebuild economics, such as INET, only led to a reassertion of old hierarchies and thinking.

This project begs to differ with these perspectives. We point to the longer timescales involved in transforming new ideas into respectable arguments in economic discourse and into defendable propositions for regulatory action (Hall, 1993 and Jasanoff, 2011, 2012).

We argue that the pre-crisis macro-prudential ideas which raised the dangers of integration between financial markets and bank business (e.g. Borio, 2003 at the BIS and other economists operating outside of the so-called ‘mainstream’) could not just simply be transposed into regulatory measures after the crisis. This was due to the mode of evidence-based regulation and the ‘regulatory science’ it attends to (Jasanoff, 2012). Ideas required validation in the language of mainstream discourse. That is, through models and statistical findings that corroborates these models (Thiemann et al., 2018).

The rise of (international) macro-prudential analysis after the crisis is arguably the most successful of these new discourses. This raises the question: to what degree does this new discourse radiate into the mainstream professional discourse?

Who are the agents of change that in the last decade have introduced this new discourse of the crisis-proneness of the financial system and its potential negative impact on the macro-economy? This project seeks to find out by applying a machine-based learning algorithm to the textual corpus produced by economists on the financial system and systemic risk post-crisis, including both published journal articles as well as working papers.

We aim to identify the main topics that emerge as well as the carriers of these ideas, where they are employed and with whom they are collaborating. The working hypothesis of the project is based on our own interview work and the literature on the sociology of knowledge (particularly the sociology of economics) is that economists in central banks and international organizations might be these ‘agents of change’.

The argument is simple and focuses on work incentives of these economists. Often schooled in some of the most advanced graduate school departments, these agents face different incentives in their work environment. Their task requirements are different, as they need to answer the action imperatives of their employer.

In that sense, advancement in their profession cannot solely rely on the extension of an old model or some methodological innovation. While important, they also need to provide their employers with economic thinking and models that make sense of immediate pre-crisis and crisis developments and answers to the pragmatic question of how far these insights should inform present action by central banks. This is different from an academic environment, in which the path-dependency of old work producing incrementally different future work prevails.

To test this hypothesis, we will investigate whether authors in policy institutions, such as Tobias Adrian, Hyun Song Shin or Stijn Claessens are central to the emergence of these topics. Bibliometric techniques are used to show whether their work is taken up by those employed in academia and/or how far it is rejected or ignored. This, we argue has an importance for both the professional economic discourse as well as regulation.

On the one hand, economic discourse has always been closely linked to power, and refusing to engage powerful economists in policy-making institutions, while weakening the regulatory impetus in the short run, could open voids into which challengers with new discourses could enter (Nagel and Thiemann, 2019). On the other hand, if mainstream discourse opens to this new vision of finance, a rethink of fundamental models, such as the Efficient Market Hypothesis will be necessary, generating change from the inside. We will consider what, if any, blockages there might be.