Alan Greenspan is apparently writing a book to determine why economic models (all of them, he says) failed to sniff out the financial crisis and ensuing recession. “While the models themselves capture the nonfinancial part of the economy rather well,” says Greenspan, “they’ve been wholly inadequate in understanding how the complex financial system works, both in the United States and globally.”

As it happens, the Levy Institute’s Hyman P. Minsky Summer Seminar just finished up, and last week Gennaro Zezza presented on the stock-flow consistent model used here at the Institute.  The approach embedded in this model, originally inspired by Wynne Godley and still being refined and expanded, is notable for the manner in which it looks at the relationship between finance and the real economy.  For an explanation of its contours and to see how it differs from some of the more orthodox models Greenspan presumably has in mind, this paper by Zezza (“Fiscal Policy and the Economics of Financial Balances”) is a good place to start.  As the paper illustrates, the model has had a pretty good track record.

Godley and Marc Lavoie’s “Monetary Economics” (recently discussed by Lavoie in a two–part interview with Philip Pilkington) describes some of the early challenges with obtaining good data on the financial flows that are part of this approach (pp. 24-25).  But as Godley and Lavoie wrote, “[t]he problem now is not so much the lack of appropriate data … but rather the unwillingness of most mainstream macroeconomists to incorporate these financial flows and capital stocks into their models, obsessed as they are with the representative optimizing microeconomic agent.”