Research area

Research on macro-financial stability

The subject

The area of macro-financial stability is at the interface between finance and macroeconomics. It deals with financial volatility in general and with financial crisis in particular. Financial crisis can take the form of banking crisis, currency crisis or fiscal crisis, or any combination of the three. A broader definition of the subject would include fragility in seemingly safe assets such as government bonds, gold and real estate.

Its importance

The area of macro-financial stability is important for four reasons in India:

1. The financial sector witnesses considerable ongoing volatility (warranted and unwarranted, good and bad, exogenous and endogenous, nominal and real). Some of this recurring volatility can be costly.

2. A financial crisis often comes as a surprise (as it did in the early 1990s in India). So, the fact that there has not been a crisis for so long does not imply that we will not have one in the short or medium term. There is a common view in India that a financial crisis happens to others, that it has not happened in India and that it is most unlikely to happen in India. This view is wrong and misleading, if not dangerous.

3. It is possible that a financial crisis is avoided due to financial repression in the economy. If so, then there are persistent low costs of financial repression even if there are hardly any occasional large costs of financial crisis. Dr. Rakesh Mohan has written a book on Growth with Financial Stability. It is about how India's macroeconomic performance has been very good. True. However, the author does not consider that the financial stability has come at a huge cost because there is ongoing financial repression, there are somewhat regular bail-outs, and surprises in higher inflation reduce the burden of debt on firms and governments (at the cost of saving households). See

Singh, Gurbachan, 2012, A review of Mohan, Rakesh, 2011, `Growth with financial stability – Central banking in an emerging economy’, Oxford Collected Essays, Oxford University Press, New Delhi, 2012. 6:3, 407-414, Margin - The Journal of Applied Economic Research

4. There is a need for research on seemingly safe assets such as government bonds, gold, and real estate, given that (a) a large proportion of savings are non-financial, (b) price of ‘space’ in many places is high, and (c) banks invest a good proportion of funds in government bonds.

There is a specialized academic journal called Journal of Financial Stability (http://www.journals.elsevier.com/journal-of-financial-stability/ ). There is also a policy journal called Financial Stability Review ( http://www.banque-france.fr/en/publications/financial-stability-review.html ). There are several other specialized publications. These are over and above what gets published on financial stability in usual journals.

The IMF has been for a long time issuing a Global Financial Stability Report (http://www.imf.org/external/pubs/ft/gfsr/2012/02/pdf/text.pdf ).

Since 2010, the RBI has started coming out with a separate bi-annual Report on Financial Stability (http://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/FFSR260612_FL.pdf ).

Macro-financial stability as distinct subject

Just as the proverbial ‘whole can be greater than the sum of parts’, similarly the area of macro-financial stability can be more than just a combination of standard macroeconomics and standard finance. This area of macro-financial stability is large in itself and it has its own nuances.

Macroeconomics is occupied with the real sector and the monetary sector, and the financial sector receives less attention. On the other hand, Finance is occupied with pricing of financial assets, and with separation of ownership and control. Even though a part of the finance literature deals with non-diversifiable risk and volatility in asset markets, there is little there that relates this volatility to macroeconomics. There is a need to have an inter-disciplinary view that includes both Finance and Macroeconomics.

The General Theory and other writings by John Maynard Keynes took a holistic approach to macroeconomics and finance. Over time, however, the two have been dealt with separately. Furthermore, economics of real estate and gold did not get much attention (in India, it may not be wrong to say that this is still not a respectable area for academic work). All this has not helped. There is a need for a change.

The bottom line is that there is a need for a holistic, rigorous and meaningful approach to research in the area of macro-financial stability.