It is widely agreed that a series of collapsing housing-market bubbles triggered the global financial crisis of 2008-2009, along with the severe recession that followed. While the United States is the best-known case, a combination of lax regulation and supervision of banks and low policy interest rates fueled similar bubbles in the United Kingdom, Spain, Ireland, Iceland, and Dubai.
Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil.
Signs that home prices are entering bubble territory in these economies include fast-rising home prices, high and rising price-to-income ratios, and high levels of mortgage debt as a share of household debt. In most advanced economies, bubbles are being inflated by very low short- and long-term interest rates. Given anemic GDP growth, high unemployment, and low inflation, the wall of liquidity generated by conventional and unconventional monetary easing is driving up asset prices, starting with home prices …
With central banks – especially in advanced economies and the high-income emerging economies – wary of using policy rates to fight bubbles, most countries are relying on macro-prudential regulation and supervision of the financial system to address frothy housing markets. That means lower loan-to-value ratios, stricter mortgage-underwriting standards, limits on second-home financing, higher counter-cyclical capital buffers for mortgage lending, higher permanent capital charges for mortgages, and restrictions on the use of pension funds for down payments on home purchases.
In most economies, these macro-prudential policies are modest, owing to policymakers’ political constraints: households, real-estate developers, and elected officials protest loudly when the central bank or the regulatory authority in charge of financial stability tries to take away the punch bowl of liquidity. They complain bitterly about regulators’ “interference” with the free market, property rights, and the sacrosanct ideal of home ownership. Thus, the political economy of housing finance limits regulators’ ability to do the right thing.
Maybe something for both L. E. O. Svensson and Paul Krugman to think about.
In a post up on his blog, Paul Krugman writes about “Mysterious Swedes” (emphasis added):
The Riksbank raised rates sharply even though inflation was below target and falling, and has only partially reversed the move even though the country is now flirting with Japanese-style deflation. Why? Because it fears a housing bubble.
This kind of fits the H.L. Mencken definition of Puritanism: “The haunting fear that someone, somewhere, may be happy.” … The underlying deficiency of demand will call for pedal-to-the-medal monetary policy as a norm. But bubbles will happen — and central bankers, always looking for reasons to snatch away punch bowls, will use them as excuses to tighten.
This is, however, rather too simplistic a view of the problems facing the Swedish economy today. And just poohpoohing — has Krugman already forgotten what happened in the US back in 00:s I would recommend consulting another Nobel laureate, Robert Shiller, for freshening up his memory — deeply felt concerns and fears of a housing bubble with conspiracy theories (“excuses”) is debating economic policies analogous to playing tennis with the nets down.
L. E. O. Svensson – former deputy governor of the Riksbank – has repeatedly during the last year lambasted the Swedish Riksbank for having pursued a policy during the last fifteen years that has increased unemployment in Sweden:
The conclusion from the analysis is thus that the actual monetary policy has led to substantially lower inflation than the target and substantially higher unemployment than a policy that would have kept the policy rate unchanged at 0.25 percent.
The Riksbank has more recently justified the tight policy by maintaining that a lower policy rate would have increased the household debt ratio (debt relative to disposable income) and would have increased any risks connected with the debt. But, as I have shown … this is not true. A lower policy rate would have led to a lower debt ratio, not a higher one. This is because a lower policy rate increases the denominator (nominal disposable income) faster than the numerator (nominal debt). Then the debt ratio falls …
In summary, the Riksbank has conducted a monetary policy that has led to far too low inflation, far too high unemployment, and a somewhat higher debt ratio compared to if the policy rate had been left at 0.25 percent from the summer of 2010 until now. This is not a good result.
By the way, the latest report The Swedish Economy by the National Institute of Economic Research includes a very interesting special study, ”The Riksbank has systematically overestimated inflation,” which may be important in this context. In an analysis of the Riksbank’s inflation forecasts, the NIER shows that Riksbank forecasts have systematically overestimated inflation. The NIER concludes that “[t]he Riksbank’s overestimation of inflation has contributed to overly tight monetary policy with higher unemployment and lower inflation than would have been the case if, on average, its inflation forecasts had been on the mark.”
Why the majority of the Executive Board so systematically has exaggerated inflation risks so systematically is a question that may be worth returning to.
The Swedish Riksbank has according to L. E. O. Svensson been pursuing a policy during the last fifteen years that in reality has made inflation on average more than half a percentage units lower than the goal set by the Riksbank. The Phillips Curve he estimates shows that unemployment as a result of this overly “austere” inflation level has been almost 1% higher than if one had stuck to the set inflation goal of 2%.
What Svensson is saying, without so many words, is that the Swedish Fed for no reason at all has made people unemployed. As a consequence of a faulty monetary policy the unemployment is considerably higher than it would have been if the Swedish Fed had done its job adequately.
So far, so good — I have no problem with Svensson’s argument about the inadequacy of the Swedish inflation targeting policies.
However, what makes the picture more complicated than Krugman — and Svensson — wants to admit, is that we do have a housing bubble in Sweden — it’s not just a figment of imagination the “bad guys” use to intimidate us with. [That said, I, of course, in no way want to imply that central bank interest rate targeting (and/or accommodations) is the best way to counteract housing bubbles. Far from it.]
The increase in house loans – and house prices – in Sweden has for many years been among the steepest in the world. Looking at the development of real house prices since 1986, there are obvious reasons to be deeply worried:
Source: Sweden Statistics
The indebtedness of the Swedish household sector has also risen to alarmingly high levels. As a result yours truly has been trying to argue with “very serious people” that it’s really high time to “take away the punch bowl.”
If Svensson and Krugman aren’t impressed by yours truly’s or Roubini’s reasoning, they will maybe at least listen to a Nobel laureate. Robert Shiller is in Sweden now — collecting his fresh Nobel prize — an commenting on his earlier warnings on a Swedish housing bubble he says he still sticks to his warning.
I think that people here in Sweden have an illusion that increasing prices is a lasting trend, but that is more suggestive of a bubble.
Svenska Dagbladet December 7
Given Shiller’s track record on the issue, I think there’s every reason in the world to take his warning seriously.
We do not instruct our students well in the art of crafting papers, possibly because there are so many idiosyncratic elements. Editing or refereeing manuscripts teaches us what distinguishes a well-crafted paper from an ordinary one. We should take on these chores not only because they are public services but also because they are the only means of learning how to write. Reading your own papers or those that are published cannot teach you the craft of writing. Unless you have put your paper away for several weeks, possibly months, you will read it with too friendly an eye and ear, for the same reason that parents are never adequate critics of their own children. And the papers that get published are a selected group that have been through countless revisions. Learn how to write from the errors of others. They provide a limitless supply:
(1) Most importantly, find a topic of substance about which you feel passionately.
(2) Then be the best detective you can be. Don’t just “round up the usual suspects”; don’t simply look under the existing lamppost. Locate new suspects. Turn on lights where they have never shone before. Follow Holmes’s dictum that “There is nothing like first-hand evidence,” as well as his admonition that “Any truth is better than indefinite doubt.”
(3) Go back and forth among theory, empirics, and stories until you iterate on the very best truth you can tell. Sherlock Holmes was known to remark that: “It is a capital mistake to theorize in advance of the facts.” And Joe Friday always sought: “the facts, Ma’m, just the facts.” They may have been great detectives, but they would have made lousy economists.
(4) And, because nothing of value is easy or simple, you must: plod, plod, plod; question, question, question; write, rewrite, and rewrite again. Be your own worst enemy, so that no one else is. Put the work away and read it with new eyes, not those of its creator.
(5) Find your own “voice.”
(6) And I hope that you will discover the importance of history and of long-term trends in the knowledge you create.
I have called my theory a general theory. I mean by this that I am chiefly concerned with the behaviour of the economic system as a whole, — with aggregate incomes, aggregate profits, aggregate output, aggregate employment, aggregate investment, aggregate saving rather than with the incomes, profits, output, employment, investment and saving of particular industries, firms or individuals. And I argue that important mistakes have been made through extending to the system as a whole conclusions which have been correctly arrived at in respect of a part of it taken in isolation.
Let me give examples of what I mean. My contention that for the system as a whole the amount of income which is saved, in the sense that it is not spent on current consumption, is and must necessarily be exactly equal to the amount of net new investment has been considered a paradox and has been the occasion of widespread controversy. The explanation of this is undoubtedly to be found in the fact that this relationship of equality between saving and investment, which necessarily holds good for the system as a whole, does not hold good at all for a particular individual. There is no reason whatever why the new investment for which I am responsible should bear any relation whatever to the amount of my own savings. Quite legitimately we regard an individual’s income as independent of what he himself consumes and invests. But this, I have to point out, should not have led us to overlook the fact that the demand arising out of the consumption and investment of one individual is the source of the incomes of other individuals, so that incomes in general are not independent, quite the contrary, of the disposition of individuals to spend and invest; and since in turn the readiness of individuals to spend and invest depends on their incomes, a relationship is set up between aggregate savings and aggregate investment which can be very easily shown, beyond any possibility of reasonable dispute, to be one of exact and necessary equality. Rightly regarded this is a banale conclusion.
Tidningen Arbetet har idag en artikel om varför makroekonomiska prognoser genomgående har väldigt låg träffsäkerhet:
Ekonomiska prognosmakare har i två års tid överskattat tillväxten. Missarna har lett till för hög ränta. Och de kan ha bidragit till ökad arbetslöshet …
Arbetets sammanställning av ekonomiska prognoser från tolv tunga prognosmakare, både inhemska och utländska, visar att stagnationen har överrumplat samtliga. Under större delen av 2011 räknade de med nära två procent eller mer i tillväxt året därpå, och likande tongångar hördes i fjol. Först i slutet av åren börjar prognoserna bli mer träffsäkra …
Jesper Hansson är prognoschef på statliga Konjunkturinstitutet, som också finns med i sammanställningen. Han tonar ned missarna.
– Tyvärr är träffsäkerheten inte så mycket sämre än normalt. Vi har fått en svagare omvärldsutveckling än förväntat, vilket har gjort att exporten varit svagare, säger han.
En som är mer kritisk till prognoserna är nationalekonomen Lars Pålsson Syll vid Malmö högskola.
– De har väldigt dålig träffsäkerhet. När ekonomin befinner sig i en lugn fas är det lätt att räkna med en ungefär likadan utveckling framöver. I oroliga tider är prognoserna sämre, och nu befinner vi oss i en sådan situation, säger han.
Bristen på precision beror, enligt Lars Pålsson Syll, på att det egentligen inte går att säga så mycket om den framtida ekonomiska utvecklingen.
– Ekonomin är inget slutet system. Det finns en massa faktorer som påverkar. I prognoserna märks en stor grad av önsketänkande. Politikerna är medvetna om att negativa prognoser kan bli självuppfyllande och bidra till en ännu sämre utveckling.
Arbetets sammanställning visar att aktuella prognoser för de kommande två åren, 2014 och 2015, har stora likheter med motsvarigheter från föregående år. I tre år har ekonomernas stalltips varit att tillväxten nästa år ska hamna kring två procent och att det blir ännu bättre drag året därpå.
Men vad talar för att prognosmakarna får rätt denna gång?
– Ingenting, säger Lars Pålsson Syll.
– Det kan hända att vi överskattar tillväxten igen. Ett par tre kvartal framåt går det med rimlig precision att förutsäga, längre fram får vi förlita oss på modeller som tenderar att gå mot historiska medelvärden, säger Jesper Hansson …
Lars Pålsson Syll går ett steg längre och hävdar att prognosverksamheten gjort mer skada än nytta för den ekonomiska politiken:
– En dålig prognos är sämre än ingen prognos alls. Prognoserna har bidragit till att politikerna suttit med armarna i kors och trott att det inte behövs fler satsningar. Det har fått effekter på den reala ekonomin genom att fler blivit arbetslösa.
Brad DeLong has a comment up on what is the real meaning of the word “microfoundations”:
I find this morning that the intelligent, thoughtful, and extremely hard-working Mark Thoma is pleading for appropriate model-using: use the right tool for the job, rather than simply building the biggest hammer you can under the assumption that everything is a nail …
But then Mike Woodford and company lost sight of the goal. Yes, New Keynesian models with more or less arbitrary micro foundations are useful for rebutting claims that all is for the best macro economically in this best of all possible macroeconomic worlds. But models with micro foundations are not of use in understanding the real economy unless you have the micro foundations right. And if you have the micro foundations wrong, all you have done is impose restrictions on yourself that prevent you from accurately fitting reality.
Thus your standard New Keynesian model will use Calvo pricing and model the current inflation rate as tightly coupled to the present value of expected future output gaps. Is this a requirement anyone really wants to put on the model intended to help us understand the world that actually exists out there? Thus your standard New Keynesian model will calculate The expected path of consumption as the solution to some Euler equation plus an intertemporal budget constraint, with current wealth and the projected real interest rate path as the only factors that matter. This is fine if you want to demonstrate that remodel can produce macroeconomic pathologies. But is it a not-stupid thing to do if you want your model to fit reality?
I totally agree with Brad – it is stupid if you want the model to fit reality. However, when confronting “modern” Neo-Walrasian macroeconomic model builders with this kind of critique, a common strategy used is to actually deny that there ever was any intention of being realistic — the sole purpose of the models are to function as bench-marks against which to judge the real world we happen to live in. For someone devoted to the study of economic methodology it is difficult not to express surprise at this unargued and nonsensical view. This is nothing but a new kind of Nirvana fallacy – and why on earth should we consider it warranted and interesting to make evaluations of real economies based on abstract imaginary fantasy worlds? It’s absolutely ridiculous from a scientific point of view. It’s like telling physiologists to evaluate the human body from the perspective of unicorns — they wouldn’t take you seriously. And is there — really — any reason whatsoever why we should judge these macroeconomic model builders differently?
Added November 5: And reading Noahpinion today I wonder if this perhaps could also be one of the main reasons why “modern” macroeconomics doesn’t work very well and
why macroeconomists have so far failed to definitively answer the following Big Questions:
1. What causes recessions?
2. Can recessions be forecast in advance?
3. Can recessions be prevented by government policy, and if so, how?
4. Why do inflations happen?
5. Why do hyperinflations happen?
6. Why do “jobless recoveries” happen, and can they be prevented?
Post Walrasians agree that a reasonable assumption of any model is agent-modeler consistency: the requirement that the agents in the model have the same information as do the economists modeling the economy. The Walrasian DSGE model achieves this agent-modeler consistency by assuming that economists know the right model; and hence to assume the agents know the right model. Rational expectations is agent-modeler consistent in this case. DSGE modelers then use the insights from thatmodel to provide guidance for situations when the agents do not know the right model.
The Post Walrasians achieve consistency by assuming that neither economists nor agents know the right model, and that a right model may well not exist. This assumption changes the analysis fundamentally because it eliminates rational expectations as the close of the model. Before one can specify agent’s expectations, one must now have an analysis of model selection and learning; there is no fixed point to fall back upon to determine rationality. Instead, one must look to how people act to determine what is rational. Behavioral economics, not utility theory, forms the microfoundation of Post Walrasian economics, and it is an empirical, not a deductive, foundation.
Using models in science usually implies that simplifications have to be made. But it comes at a price. There is always a trade-off between rigour and analytical tractability on the one hand, and relevance and realism on the other. “Modern” — Walrasian Dynamic Stochastic General Equilibrium — macroeconomic models err on the side of rigour and analytical tractability. They fail to meet Einstein’s ‘Not More So’ criterion — thereby making macroeconomics less useful and more simplistic than necessary. Models should be as simple as possible — but ‘Not More So.’
Yesterday David Fields — of Naked Keynesianism — wondered what was my position on the fact that some heterodox economists would consider the IS-LM framework “to still be relevant if given enough flexibility without neoclassical synthesized elements.”
I will sure come back on this when time admits a more thorough analysis, but let me start by giving at least a tentative answer — focusing on where I think IS-LM doesn’t adequately reflect the width and depth of Keynes’s insights on the workings of modern market economies.
• Almost nothing in the post-General Theory writings of Keynes suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought. In Keynes’s canonical statement of the essence of his theory — in the famous 1937 Quarterly Journal of Economics article — there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. John Hicks, the man who invented IS-LM in his 1937 Econometrica review of Keynes’ General Theory – “Mr. Keynes and the ‘Classics’. A Suggested Interpretation” — returned to it in an article in 1980 — “IS-LM: an explanation” — in Journal of Post Keynesian Economics. Self-critically he wrote that ”the only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate.” What Hicks acknowledges in 1980 is basically that his original IS-LM model ignored significant parts of Keynes’ theory. IS-LM is inherently a temporary general equilibrium model. However — much of the discussions we have in macroeconomics is about timing and the speed of relative adjustments of quantities, commodity prices and wages — on which IS-LM doesn’t have much to say.
• IS-LM forces to a large extent the analysis into a static comparative equilibrium setting that doesn’t in any substantial way reflect the processual nature of what takes place in historical time. To me Keynes’s analysis is in fact inherently dynamic — at least in the sense that it was based on real historic time and not the logical-ergodic-non-entropic time concept used in most neoclassical model building. And as Niels Bohr used to say — thinking is not the same as just being logical …
• IS-LM reduces interaction between real and nominal entities to a rather constrained interest mechanism which is far too simplistic for analyzing complex financialised modern market economies.
• IS-LM gives no place for real money, but rather trivializes the role that money and finance play in modern market economies. As Hicks, commenting on his IS-LM construct, had it in 1980 — “one did not have to bother about the market for loanable funds.” From the perspective of modern monetary theory, it’s obvious that IS-LM to a large extent ignores the fact that money in modern market economies is created in the process of financing — and not as IS-LM depicts it, something that central banks determine.
• IS-LM is typically set in a current values numéraire framework that definitely downgrades the importance of expectations and uncertainty — and a fortiori gives too large a role for interests as ruling the roost when it comes to investments and liquidity preferences. In this regard it is actually as bad as all the modern microfounded Neo-Walrasian-New-Keynesian models where Keynesian genuine uncertainty and expectations aren’t really modelled. Especially the two-dimensionality of Keynesian uncertainty — both a question of probability and “confidence” — has been impossible to incorporate into this framework, which basically presupposes people following the dictates of expected utility theory (high probability may mean nothing if the agent has low “confidence” in it). Reducing uncertainty to risk — implicit in most analyses building on IS-LM models — is nothing but hand waving. According to Keynes we live in a world permeated by unmeasurable uncertainty -– not quantifiable stochastic risk –- which often forces us to make decisions based on anything but “rational expectations.” Keynes rather thinks that we base our expectations on the “confidence” or “weight” we put on different events and alternatives. To Keynes expectations are a question of weighing probabilities by “degrees of belief,” beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modeled by “modern” social sciences. And often we “simply do not know.” As Keynes writes in A Treatise on Probability:
The kind of fundamental assumption about the character of material laws, on which scientists appear commonly to act, seems to me to be [that] the system of the material universe must consist of bodies … such that each of them exercises its own separate, independent, and invariable effect, a change of the total state being compounded of a number of separate changes each of which is solely due to a separate portion of the preceding state … Yet there might well be quite different laws for wholes of different degrees of complexity, and laws of connection between complexes which could not be stated in terms of laws connecting individual parts … If different wholes were subject to different laws qua wholes and not simply on account of and in proportion to the differences of their parts, knowledge of a part could not lead, it would seem, even to presumptive or probable knowledge as to its association with other parts … In my judgment, the practical usefulness of those modes of inference … on which the boasted knowledge of modern science depends, can only exist … if the universe of phenomena does in fact present those peculiar characteristics of atomism and limited variety which appears more and more clearly as the ultimate result to which material science is tending.
Models can never be more than a starting point in the endeavour of finding causal mechanisms. Consequently we cannot — from a relevant and realistic point of view — simpliciter presuppose that what has worked before, will continue to do so in the future. How strange then that macroeconomic models — IS-LM included — as a rule do not even touch upon these aspects of scientific methodology that seems to be so fundamental and important for anyone trying to understand how we learn and orient ourselves in an uncertain world. An educated guess on why this is a fact would be that Keynes’s concepts are not possible to squeeze into a single calculable numerical “probability.” In the quest for quantities one – IS-LM models included — puts a blind eye to qualities and looks the other way.
Why is this important? Because the kind of involuntary unemployment and low investment activity that intermittently characterizes modern market economies is basically impossible to understand without weighing in the kind of uncertainties and expectations that was at the forefront of Keynes’s analysis.
• IS-LM not only ignores genuine uncertainty, but also the essentially complex and cyclical character of economies and investment activities, speculation, endogenous money, labour market conditions, and the importance of income distribution. And as Axel Leijonhufvud so eloquently notes on IS-LM economics — “one doesn’t find many inklings of the adaptive dynamics behind the explicit statics.” Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.
Thirty years ago — as a young research stipendiate in the U.S. — yours truly had the great pleasure and privelege of having Hyman Minsky as teacher. He was a great inspiration at the time. He still is — and the points I have made here are some of the main reasons why I still think Hyman was right when maintaining that “Keynes without uncertainty is rather like Hamlet without the Prince,” and characterizing IS-LM as an “unfair and naive representation of Keynes’s subtle and sophisticated views”:
The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …
The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …
The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …
As all students of economics know, time is limited. Given that, there has to be better ways to optimize its utilization than spending hours and hours working through or constructing irrelevant economic models. I rather recommend my students to allocate some time to study great forerunners like Keynes and Minsky, helping them to construct better, real and relevant economic models – models that really help us to explain and understand reality.
Instead of real maturity, we see that general equilibrium theory possesses only pseudo-maturity. For the description of the economic system, mathematical economics has succeeded in constructing a formalized theoretical structure, thus giving an impression of maturity, but one of the main criteria of maturity, namely, verification, has hardly been satisfied. In comparison to the amount of work devoted to the construction of the abstract theory, the amount of effort which has been applied, up to now, in checking the assumptions and statements seems inconsequential.
Paul Krugman writes on his blog today re economic models:
Look, economics is about how people (the word “agents” is itself a kind of tribal marker) are motivated to take actions, and how those actions interact. Equilibrium is often a very convenient way to think through all of that, and all of us sometimes use wording about what the economy “needs” or “requires” as shorthand …
The trouble is that we have a lot of economists who apparently don’t understand why they’re doing what they’re doing; they solve their equations without even trying to picture what those equations are supposed to be saying about the actual behavior of consumers and firms.
It’s a very sad state of affairs.
Indeed. A very sad state of affairs — on which Friedrich von Hayek (the “good” one) wrote in his Lecture to the memory of Alfred Nobel, December 11, 1974:
It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the “scientistic” attitude – an attitude which, as I defined it some thirty years ago, “is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.”
Amongst the several problems/disadvantages of this current consensus is that, in order to make a rational expectations, micro-founded model mathematically and analytically tractable it has been necessary in general to impose some (absurdly) simplifying assumptions, notably the existence of representative agents, who never default.This latter (nonsensical) assumption goes under the jargon term as the transversality condition.
This makes all agents perfectly creditworthy. Over any horizon there is only one interest rate facing all agents, i.e. no risk premia. All transactions can be undertaken in capital markets; there is no role for banks. Since all IOUs are perfectly creditworthy, there is no need for money. There are no credit constraints. Everyone is angelic; there is no fraud; and this is supposed to be properly micro-founded!
Charles Goodhart (former member of the Bank of England’s Monetary Policy Committe)