Towards a New Research Programme on ‘Banking and the Economy’ – Implications of the Quantity Theory of Credit for the Prevention and Resolution of Banking and Debt Crises

The financial crisis has triggered a new consensus among economists that it is necessary to include a banking sector in macroeconomic models. It is also necessary for the finance and banking literature to consider how best to incorporate systemic, macroeconomic feedbacks into its modeling of financial intermediation. Thus a new research programme on the link between banking and the economy is needed. This special issue is devoted to this theme. In this paper an overview of the issues and problems in the economics and finance literature is presented, and a concrete, simple approach is identified of how to incorporate banks into a macroeconomic model that solves many of these issues. The model distinguishes between the type of credit that boosts GDP and credit that is associated with asset prices and banking crises. The model is consistent with the empirical record. Some applications are discussed, namely the prediction and prevention of banking crises, implications for fiscal policy, and a solution to the European sovereign debt crisis that stimulates growth while avoiding the corner solutions of euro exit or fiscal union.