Leverage cycles (wonkish)

23 Oct, 2012 at 17:22 | Posted in Economics | Comments Off on Leverage cycles (wonkish)

John Geanakoplos has a great lecture at Yale University on why central banks should pay much more attention to leverage cycles.He is forcefully arguing that one of the missing ingredients in the macro models used by central banks today are endogenous default and endogenous lending terms distinct from the interest rate. Focussing to much on interest rates have made them unable to recognise that changes in the perception of potential defaults can have serious repercussions on economic activities. It has also made central banks unable to detect the financial bubbles and to a faulty understanding of the nature of debt and leverage. In short – central banks have to a large degree based their policies on the wrong models.