Macroeconomics and Financial Crises: Bound Together by Information Dynamics
Jul 2023 · Princeton University Press
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How financial crises are inherent features of macroeconomic dynamics
There are no bigger disruptions in the functioning of economies than financial crises. Yet prior to the crash of 2007–2008, macroeconomics incorporated financial crises simply as bad shocks, like earthquakes, failing to consider them as an intrinsic phenomenon of the evolution of macroeconomic variables, such as credit, investment, and productivity. Macroeconomics and Financial Crises rethinks how technological change, credit booms, and endogenous information production combine to generate financial crises as inherent and recurrent reactions to macroeconomic dynamics.
Gary Gorton and Guillermo Ordoñez identify short-term debt, collateral, and information as common elements that are present in all financial crises. Short-term debt is a critical element for storing value over short periods without fear of loss, but there needs to be collateral backing the debt. Critically, the collateral should be such that no agent wants to produce information about its quality. The debt backed by such collateral is information-insensitive. Gorton and Ordoñez argue that, during a credit boom, as more and more firms get loans, the economy reaches a tipping point where information production becomes too tempting, disrupting short-term debt and cutting most firms out of the credit market.
Showing how a financial crisis is an information event triggered by the dynamics of macroeconomic variables, Macroeconomics and Financial Crises provides new perspectives on the intricate relations between macroeconomics and financial crises.
There are no bigger disruptions in the functioning of economies than financial crises. Yet prior to the crash of 2007–2008, macroeconomics incorporated financial crises simply as bad shocks, like earthquakes, failing to consider them as an intrinsic phenomenon of the evolution of macroeconomic variables, such as credit, investment, and productivity. Macroeconomics and Financial Crises rethinks how technological change, credit booms, and endogenous information production combine to generate financial crises as inherent and recurrent reactions to macroeconomic dynamics.
Gary Gorton and Guillermo Ordoñez identify short-term debt, collateral, and information as common elements that are present in all financial crises. Short-term debt is a critical element for storing value over short periods without fear of loss, but there needs to be collateral backing the debt. Critically, the collateral should be such that no agent wants to produce information about its quality. The debt backed by such collateral is information-insensitive. Gorton and Ordoñez argue that, during a credit boom, as more and more firms get loans, the economy reaches a tipping point where information production becomes too tempting, disrupting short-term debt and cutting most firms out of the credit market.
Showing how a financial crisis is an information event triggered by the dynamics of macroeconomic variables, Macroeconomics and Financial Crises provides new perspectives on the intricate relations between macroeconomics and financial crises.
How financial crises are inherent features of macroeconomic dynamics
There are no bigger disruptions in the functioning of economies than financial crises. Yet prior to the crash of 2007–2008, macroeconomics incorporated financial crises simply as bad shocks, like earthquakes, failing to conside...
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About the author
Gary B. Gorton is the Frederick Frank Class of 1954 Professor of Finance at the Yale School of Management. His books include Slapped by the Invisible Hand and (with Ellis W. Tallman) Fighting Financial Crises. Guillermo L. Ordoñez is professor of economics and finance at the University of Pennsylvania and an editor of the Journal of Economic Theory.
Gary B. Gorton is the Frederick Frank Class of 1954 Professor of Finance at the Yale School of Management. His books include Slapped by the Invisible Hand and (with Ellis W. Tallman) Fighting Financial Crises. Guillermo L. Ordoñez is professor of economics and finance at the University of Pennsyl...
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