Institute of Information Theory and Automation

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Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents

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The ability of financial markets to bear risk is central to economic welfare and stability. Growth and economic wellbeing is inhibited if financial markets are unable to transfer resources efficiently from the suppliers of liquiditz to entrepreneurs. However, this proper functioning of financial markets has been distorted by levels of volatility considerably in excess of those implied by fundamentals. Markets have undergone dramatic crashes and they display speculative bubbles with market prices far removed from their equilibrium values. Economic research has hitherto been to make only limited progress in resolving these important practical and policy relevant issues of the apparent instability in financial markets.This proposal seeks to develop elements of a new paradigm which (i)explicity takes into account the existence of various forms of heteregoneous, boundedly rational behaviour in financial markets as well as in goods and labour markets, (ii)investigates thepotential of such behaviour to generate bubbles, crashes and a systém-wide break down of aktivity as collective outcomes of individual activities, (iii)investigates the linkages and repercussions between the complex area of financial aktivity and realeconomic aktivity which could be affected by e.g., the cancellation of credit lines and a breakdown of expected liquidity provosion, (iv) studies how the transmission channel of monetary policy works in times of distress in the financial markets (particularly the interbank markets and how it could restore the credit flow from banks to companies operating in the real sector. We will adopt a methodologically pluralistic approach trying to augment existing macro models and construct new (agent-based) ones from bottom-up. The results will provide insights into the consequences of different modelling paradigms for the conduct of monetary policy, and in particular, appropriate reactions of modetary authorities to prevalet dinancial distress.
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2015-01-05 22:06