Why CRISIS is needed

The global financial crisis destroyed the faith that both policymakers and the general public had in the traditional economic models and thinking that had failed to foresee the disaster.

The CRISIS project aims to fill that gap by developing a new approach to economic modelling and understanding risks and instabilities in the global economy and financial system.

In his opening address to the European Central Bank’s annual conference on 18 November 2010, ECB President Jean-Claude Trichet said “macro models failed to predict the crisis”, adding: “In the face of the crisis, we felt abandoned by conventional tools”.

The models and tools that central banks, finance ministries, and regulators still use today generally rely on three key assumptions:

  1. Households, firms, and governments are perfectly rational and tend to behave in similar ways to each other.
  2. Markets always ensure supply and demand balance and the economy settles into a balanced “equilibrium” state.
  3. The detailed institutional structures and interconnections of the financial system – the ‘plumbing’ of financial markets – do not generally matter for macroeconomic policy.

One lesson from the crisis was that the models failed to match how people and institutions behaved. This meant all three assumptions were wrong: markets failed to clear; major economic imbalances emerged; and the plumbing connections had systemic impacts on the economy.

The CRISIS model will be very different from current models in a number of key ways. It will:

  • be a “bottom-up” rather than “top-down” model that takes account of the different ways households, firms and governments behave;
  • incorporate the latest evidence from behavioural economics;
  • collect new data on how people make decisions using experimental economic techniques;
  • explicitly look at the network and institutional structure of the financial system and how that impacts on the economy; and
  • test the model using empirical data.