An Introduction to the Finance Hub

Ekaterina Svetlova

Since the Global Financial Crisis, there has been a growing movement to reconsider the tools and methods used by the economics profession. Critics provide examples of what macroeconomic models omit and perhaps cannot accomplish. In the search for new ideas, an interdisciplinary approach may open-up some new lines of enquiry and even potential answers. The task of the Finance Hub is to consider how interdisciplinary enquiry and the introduction of new methods can shed light on the question, ‘Is the Financial System Fit for Purpose?’

The justification for an interdisciplinary approach and possibly introducing new methods begins where the ability of economics to satisfactorily explain observed phenomena ends. To tackle these problems, I intend to focus the Hub’s work in two areas: content and methodology.

Work on content includes adjusting the existing framework and even considering new macroeconomic concepts i.e. new categories. With respect to the question, ‘Is financial system fit for purpose?’ the overall goal of the financial system is to efficiently allocate monetary resources under uncertainty as opposed to simply risk. But what is money today and what are the uncertainties we face? The Hub’s discovery meeting in January made clear that answers to these questions are not solely of an economic nature.

The allocation of resources and risks through the financial system cannot be understood without concepts of uncertainty, non-knowledge, reciprocity, power, herding, trust and social construction of money, interest rates and liquidity. Thus the discovery meeting suggested that rethinking the role of the financial system is hardly conceivable without the joint work on content with sociology, anthropology, jurisprudence and psychology.

One of the categories in macroeconomics that requires joint rethinking is ‘money.’ The popularity of cryptocurrencies and digital credits has changed our understanding of ‘moneyness’, money creation and its distribution. The rejection in July by the Securities and Exchange Commission (SEC) to list a bitcoin Exchange-traded fund (ETF) demonstrates that money matters not only for economists but also lawyers and economic historians.

What kind of financial innovation are digital currencies and would they benefit the economy? How would this new form of money co-exist and interact with existing forms of money? And if money is a social convention, this simply begs the question of what this convention implies and what is the role of public institutions. Does this new type of money jeopardise stability by being prone to manipulation or fraud? What is the best way to protect investors by law? Are cryptocurrencies a genuinely new type of financial innovation, or are there parallels with historical episodes?

Furthermore, the sociologist might ask, “if money, like language, is based on social convention, how does digitalization transform this convention? Also, if liquidity is a social construct, how might this change in the new and evolving monetary landscape?” The Hub will seek to address these questions in two interdisciplinary workshops on FinTech and the new roles of central banking.

The other interdisciplinary issue is our understanding of financial risks. The change of focus from exogenous to systemic, or endogenous, risk (the risk created within the financial system) has already happened in some areas of macroeconomic research. It is acknowledged that the mitigation of systemic risks is one of the main goals of prudential financial regulation, yet the phenomenon itself is still poorly understood. Can systemic risk ever be measured appropriately, and is optimisation an appropriate framework for its control?

Other areas of social science may enhance our understanding of these issues. For example, on whether endogenous risk could result from social interactions. This is because risk may arise when independent heterogeneous actors interact with one another and orientate their expectations and decisions toward the expectations and decisions of others. The result often produces unpredictable meso and macro effects. However, we have a limited understanding of the empirical forms this reflexivity takes and how the recursive character of expectations influences macro outcomes and contributes to the system instability.

The Hub will host a workshop on financial resilience in order to support investigations into the micro (individual) and macro (system) dimensions of financial resilience and its threats. We will ask how financial resilience is different from resilience in general, and what theories or approaches can be built upon.

Alongside working on content, the Hub will also look at methodology. The methods of other social sciences, such as interviews and participant observations, have been widely dismissed by macroeconomists (notable exceptions include Bewley (1999) and Piore (1995, 2006)). At the same time, Akerlof and Kranton (2010) acknowledge that one of the major means of enriching macroeconomics is observation. Similarly, Tuckett (2017) argues in favour of “the design and implementation of many more observational and interview studies with a clear macroeconomic focus.”

Existing and new methods could be supported by empirical data from interviews and observational fieldwork. For example, enriching current micro foundations or building the fundamental framework of agent-based modelling. These methods are indispensable if we are to understand how heterogeneous agents, expectations and reflexivity in financial markets can be modelled.

Also, network analysis is a promising method for examining communication and interdependencies among market actors. The interdependencies that contribute to the establishment of herding and impact the market-wide phenomena such as prices and risk (Kellard et al. 2017). Following this line of inquiry, the Hub will hold a large conference on methodology and data in macroeconomics. One of the exciting interdisciplinary research projects already being funded by Rebuilding Macroeconomics examines the real-time influence of narratives on policy decision making at the Bank of England.

The extraordinary abstraction of finance in mainstream macroeconomic models has been a deficit to the usefulness of the subject. We suggest that in order to overcome this, we should take a look at the intricacies and uniqueness of the financial system through an interdisciplinary lens. Our workshops, meetings and conferences will be crucibles for discussing new ideas and designing research calls which we hope will motivate new research into whether our financial system is indeed fit for purpose.