The parlous state of macroeconomics and the optimal financial structure

Macroeconomics remains in a parlous condition, largely because it has assumed away all financial frictions. Ultimately these latter depend on the possibility that borrowers might default on their repayments. Without default, there is no real role for most financial intermediations, collateral, liquidity or money. Yet default (especially of banks, the key ingredient of crises) is rarely modelled. In order to make banks safer, in the aftermath of the Great Financial Crisis, there are various proposals to restructure our banking systems, for example to dismantle universal banks into separate retail and investment parts. This partly derives from a mis-reading of the causes of the GFC, which was largely driven by an interaction between a housing boom and a bank credit expansion surfeit, thereby exaggerating leverage, mis-match and non-core bank finance. The need is for regulatory improvements that address these weaknesses.