The macroeconomic theories and models favored by academics, as well as those used more commonly by policymakers, effectively rule out by assumption economic and financial crises of the sort we are living through. (In particular, the longer-run dangers posed by the rapid expansion of credit and resulting private-sector balance-sheet developments are almost wholly ignored.) As a result, the current crisis was neither anticipated nor prepared for, and the crisis was also less well managed than it might have been. At the level of macroeconomic theory and modeling, this experience suggests that basic Keynesian insights need to be complemented by some insights from the Austrian school as well as those of Minsky. (Demand factors are important, but so too are supply-side and financial considerations.) Such a synthesis provides a reasonable explanation of the crisis and points to some of the difficulties likely to be faced in emerging from it. As for the policy implications in current circumstances, it needs to be better recognized that policies with positive short-run effects can have negative effects over a longer time period. If, as a result, fiscal expansion and monetary expansion have now reached their limits in some countries, supply-side policies must be given greater emphasis. (These would include measures to encourage investment, both private and public, as well as other structural measures to raise the potential growth rate of the economy.) Such measures, along with more decisive efforts to reduce the "headwinds" of over-indebtedness, should with time provide the foundations for a sustainable economic recovery.
Keywords: Macroeconomics; Bubble; Financial crisis
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.