Discuss research on the role of banks and other financial ...

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Discuss research on the role of banks and other financial institutions in the intermediation of funds between lenders and borrowers.
 
  What will be an ideal response?

Question 2

Discuss the major intellectual failure on macroeconomics from the crisis.
 
  What will be an ideal response?

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Answer to Question 1

Work by Doug Diamond and Philip Dybvig in the 1980s had clarified the nature of bank runs : liquid assets and liquid liabilities created a risk of runs even for solvent banks. The problem could only be avoided by the provision of liquidity by the central bank if and when needed. Work by Bengt Holmstrm and Jean Tirole had shown that liquidity issues were endemic to a modern economy. Andrei Shleifer discussed the limits of arbitrage. Behavioral economists had pointed to the way in which individuals differ from the rational individual model typically used in economics, and had drawn implications for financial markets.

Answer to Question 2

The failure was in not realizing that such a large crisis could happen,that the characteristics of the economy were such that a relatively small shock, in this case the decrease in U.S. housing prices, could lead to a major financial and macroeconomic global crisis. The source of the failure, in turn, was a lack of focus on the role of the financial institutions in the economy.

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Correct answers!

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