WHY IS FINANCE IMPORTANT? SOME THOUGHTS ON POST-CRISIS ECONOMICS
Abstract
The global financial crisis of 2008 challenges some relevant aspects of macroeconomic theory such as the neutrality of money. This paper shows that this neutrality is based on the unrealistic assumption of perfect competition. Relaxing this alone (without time lags, price rigidities, menu costs and other frictions) makes money no longer necessarily neutral and hence makes financial crises and institutions much more important. The presence of increasing returns to scale at the firm level and to specialization at the economy level due to the division of labor also makes finance much more important than suggested by traditional economics.
This is a revised version of an invited paper presented at the Singapore Economic Review Conference held on August 2013. Comments from participants and others are gratefully acknowledged.
