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My PhD dissertation topic was trade creation and trade diversion in the European economic community. In that research, completed in 1967, I applied a rudimentary disaggregated, partialequilibrium methodology focused on trade flows. Today’s approaches exploit computable general equilibrium (CGE) models, but they share an almost exclusive focus on effects on economic activity, on trade and the real economy rather than on finance and financial markets, and, in particular, not vice versa. The gap between trade and finance is large.
Why do we have this gap? I suggest three reasons: institutional, philosophical, and technical. The institutional reason is that the field of international economics these days has two distinct branches: trade and finance. In the 1960s, they were more integrated. I wrote my trade dissertation under Bob Triffin, a prominent international monetary economist; Dick Cooper, whose field was international finance; and Steve Hymer, whose field was foreign investment and development. (I myself have spent most of my career working on international financial issues.) The philosophical reason is that in most of our models money and finance are neutral. The technical reason is that CGE models and their more sophisticated cousins, dynamic stochastic general equilibrium (DSGE) models have rudimentary financial sectors. In part the reason is because finance as a field has not yet generated useful regularities for macroeconomic models. But there is a problem with these models: they must have a well-defined equilibrium in order to be solved. On the other hand, we know that financial markets often behave as if there is no equilibrium or no nearby equilibrium, and we have recently relearned that financial market disruptions and the financial side of the economy can have important influences on the real economy. Financial market disruptions may be temporary, but temporary can last for years.
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