Evans: No Good Tools to Analyze Financial Shocks

Financial shocks can be complicated because there are no tools to analyze them, Federal Reserve Bank of Chicago president Charles L. Evans told an audience Friday.

“The events of the past year certainly have reminded us of this point,” he said, according to text of a speech he delivered in Switzerland.

“We need to be able to model how various disruptions in financial markets affect credit provision, and how these effects, in turn, impact the real economy,” he said. “Ideally, we would want to analyze these financial developments using a well-articulated and empirically implementable modeling framework. Executing this program is tricky business. And, as I will discuss, I think we still have some work left to do — first in better understanding the fundamentals underlying the current financial shocks, and, once we do, in figuring out how to best adjust our empirical models to measure their influence on the macroeconomy.”

The various empirical models leave many unanswered questions, Evans noted. “So my guess is that we can not gain a good deal of insight into when markets will 'return to normal,’ and what 'normal’ will look like from these models’ estimated impulse response functions,” he said. “Indeed, the rarity of crisis events and changes in the structure of markets makes it difficult to use even simple statistics, such as risk spreads and volatility measures, to gauge the path to the 'new normal.’ ”

“To answer all of these challenging questions, it will be extremely useful to seek a more unified perspective of the role of financial frictions in modern macroeconomic models,” Evans said. “In this way, we will be able to identify the independent roles of our traditional monetary policy tools and our new lending facilities, as well as the interaction between the old and new tools. Developing these models is up to the research community — from the research shops at central banks to academic departments to independent think tanks. And we policymakers are eagerly awaiting the results.”

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