Macroeconomics of finance

In my Financial Institutions and Products course on the MFin, I give a brief introduction to national accounts and a way of thinking about macroeconomics that is relatively simple but allows us to explain a lot. It draws on the definitions of current and capital account spending and on the identity that sectoral financial balances (net acquisition of financial assets) must sum to zero. An accounting framework doesn’t give you any predictions or analysis until you add a theory of behaviour such as why households save. But without having to construct complex equations the framework allows us to understand the macro situation in individual countries and at the international level (including the Eurozone).

This is not a framework found in most macro textbooks, though it is quite consistent with the way that the IMF looks at the world. The best source for further information is the writing of Martin Wolf, both in his Financial Times columns (twice a week) and in his book “Fixing Global Finance“, published in 2008. This is an excellent analysis of how to think about the global financial imbalances that underpin the world economic difficulties and how to possibly fix them (though I think he has become more pessimistic since he wrote the book).

The framework that Martin uses is based on work done by various people including the late Professor Wynne Godley, of Cambridge University, whom I was lucky enough to know somewhat. Wynne was a very interesting man (originally a professional oboe player) and tried to influence modern macroeconomics away from the highly mathematical equations that often contained very little economic content and omitted any serious consideration of the financial system. In this he was not successful but his analysis of the imbalances in the US and UK economies meant he was more often correct in his predictions than the more orthodox economists. Martin Wolf shows almost every week how this framework is so valuable for understanding the world economy.

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