June 12, 2012
The 2008 financial crisis that shook the U.S. and world economies revealed serious gaps in the ability of researchers, regulators and economists to define and measure so-called systemic risk—the risk of an entire market or financial system collapsing.
New economic models are needed to better understand policies designed to prevent systemic risk. To meet that need, the Alfred P. Sloan Foundation has given the University of Chicago’s Becker Friedman Institute for Research in Economics $1 million to help develop the next generation of policy tools that explicitly address links between the macroeconomy and the financial sector.
“Federal agencies have been created and charged with the task of identifying threats to the economic stability of the United States and managing systemic risk, but it’s not clear that we know how to identify these risks,” said Lars Peter Hansen, research director of the Becker Friedman Institute. “The research arms of regulatory agencies do not know precisely what they are measuring and they do not have the quantitative tools they need. That’s a huge challenge, and it opens the door to regulatory discretion and unintended consequences.”
The grant will fund the three-year Macroeconomic Modeling and Systemic Risk Research Initiative, which has assembled a group of experts with complementary knowledge and skills from the University of Chicago and other academic institutions around the country. This Macro Financial Modeling (MFM) Group will meet regularly to discuss fruitful approaches and advance new models.
The Sloan grant will provide research assistance and data sets to support the development of macroeconomic models that better incorporate the impact of financial sector activities and software for evaluating these new models. The aim of the Initiative is to produce practical tools for assessing systemic risk stemming from activities in the financial sector that can impact the economy as a whole.
“This will be a long-term endeavor, but we are fortunate to be able to draw on some of the world’s best macro- and financial economists who have been thinking deeply about this challenge for some time,” said Andy Lo, professor of finance and director of the Laboratory for Financial Engineering at the MIT Sloan School of Management.
Lo and Hansen, the David Rockefeller Distinguished Service Professor at the University of Chicago, are principal investigators of the Initiative and members of the MFM Group, which also includes scholars from New York University and Princeton University, as well as from the Massachusetts Institute of Technology and University of Chicago. The Initiative is a collaboration of the Becker Friedman Institute and the MIT Laboratory for Financial Engineering.
“This modeling and systemic risk research Initiative is an excellent example of the Becker Friedman Institute’s capacity to pull together leading experts around a critically important topic and to generate new knowledge tools that are sorely needed,” said Ken Olliff, co-director of Arete, a research accelerator led by the Office of the Vice President for Research and National Laboratories in collaboration with the University’s Office of Corporate and Foundation Relations.
These tools will be based on theory but also grounded on empirical evidence. Officials from the Federal Reserve attended an early MFM Group meeting and gave a presentation about new regulatory mandates and their efforts to collect data and measure systemic risk.
In addition to developing new and improved software for macroeconomic modeling, publishing papers and building an online compendium of research related to better measurement of systemic risk, the Initiative will provide funds for new, young doctoral students to write their dissertations and pursue innovative work on macroeconomic models about linkages between economic sectors or related topics.
Established in 2011 by joining the Friedman Institute and the Becker Center on Chicago Price Theory, the Becker Friedman Institute builds bridges across disciplines and subfields in economics, fostering conversations and collaborations that sharpen research and spark new ideas.
Founded in 1934, the Sloan Foundation makes grants to support original research and broad-based education related to science, technology and economic performance; and to improve the quality of American life.
By Greg Borzo