Abstract
In this paper, an inductive research methodology and the principle of parsimony are applied to reconsider a central issue in economics and macro-finance, namely the determinants of economic growth and the role of the financial sector. A simple framework is derived, characterised by information imperfections and the absence of market clearing. The literature on rationing has identified the need to consider differing rationing regimes but has not included a banking sector. Such a set-up is presented in this paper, which identifies the link between credit and economic growth under differing rationing regimes, with varying consequences for inflation. The familiar case of money creation resulting in inflation features as a special case within the general framework. Others are the possibility of asset price bubbles and collapses, non-inflationary growth despite full employment, and instability in banking systems. The model is consistent with empirical evidence that has been difficult to reconcile with conventional equilibrium models. It is found that within this simple rationing framework, banks, left to their own devices, do not necessarily deliver stable, non-inflationary growth, and there is no reason to expect their behaviour to optimise social welfare. Some implications for research and policy are discussed.
Highlights
Since the 2008 banking crisis, criticism of mod ern macroeconomics has become frequent
By examining five rationing regimes, the model is found to be consistent with em pirical evidence that has been difficult to rec oncile with conventional equilibrium models
The model seems consistent with the empirical evidence on credit, disaggregated credit and its link to the economy
Summary
Since the 2008 banking crisis, criticism of mod ern macroeconomics has become frequent. 605).1De Grauwe (2010) like wise criticised the dominant general equilib rium models and their “extraordinary” assump tions. These have been the logical result of the consistent application of the deductive (or ‘hypothetico-deductive’) research methodology. A common defence of the approach often used in macroeconomics is that unrealistic assump tions and a general equilibrium framework are necessary to establish a benchmark to compare reality with. This paper aims to present and apply an al ternative research strategy that starts ‘squarely from a different benchmark’ but is successful. It attempts to do so by not adopting the deductive methodology. That is the inductive research methodology which this paper relies upon
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