Imperfect Knowledge

Innovation. The word is evocative of ideas, products and processes which have somehow made the world a better place. Prior to the global financial crisis, many viewed financial innovation as unequivocally falling into this category.

There is much anecdotal evidence in the popular media, backed up by survey research, that participants in currency markets pay close attention to fundamental economic variables in forming their forecasts of future exchange rates.

For macroeconomists, an individual is rational if she uses her understanding of the way the economy works in making decisions that do not conflict with her objectives.

The present-value model of stock prices is a workhorse in financial economics. The model relates today’s price of a stock (or a basket of stocks) to the market’s forecasts of next-period’s price and dividend, appropriately discounted.

In this paper, we examine one of the core puzzles in International Macroeconomics, the so-called “forward-discount anomaly.”

A core premise of contemporary economic models is that researchers can adequately specify in probabilistic terms how individuals alter the way they make decisions and how the processes underpinning market outcomes unfold over time.

A core puzzle in Önancial economics is the inability of standard risk-premium models to account for excess returns in currency and other asset markets.

The first part of this text comes back on the standard economic viewpoint on expectational coordination, a viewpoint that the recent events have challenged.

Uncertainty is an unavoidable feature of economic life, although we may cope with it sometimes by ignoring it. Institutions, conventions and behaviour are all conditioned by uncertainty, and they in turn condition uncertainty in a reflexive manner.

My remarks today will be focused primarily on features of the developed world’s financial system which led to the crisis of 2008 and to the Great Recession that followed, from which we are only slowly and painfully emerging.

In his recent lecture at the Cass Business School, Lord Turner noted that even mentioning the possibility of overt monetary financing was akin to breaking a taboo.