- New Directions in Modern Economics series
Chapter 2: Financial Instability
2. Financial instability 1. THE IMPACT OF RECENT EVENTS There has always been an interrelationship between facts and theories, even though it is not so easy to identify its precise pattern. On one hand, theories allow one to separate facts that are relevant from those that are peripheral, to identify the deep links between them and to set aside those that are only apparent. On the other, certain facts can challenge existing theories either because they cannot be understood within the extant theoretical paradigms or because it is more parsimonious to look for other explanations outside the mainstream. These interrelationships are not just typical of economics; they also occur in other sciences. Furthermore, their impact can be historically dependent. For instance, the events of the 1930s are an example of these links, when the Great Depression helped to strengthen macroeconomics, a discipline that was just about to take off then. The same thing happened, even though on a smaller scale, when the first oil shocks occurred. Rational expectations became central at those times. Macroeconomics became microfounded and supply-side economics replaced Keynesian policies. Facts matter for theories, even though the latter have their own inertia. The recent events that marked the world economy have been both more severe and more widespread than those experienced in previous post-war recessions. Actually, they look like the Great Depression more than anything else. One might infer that important theoretical changes are ahead, even though it is very difficult to anticipate their direction. There are three...
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