Meeting in unsuspected places Many of the connections between the economy and finance were perceived to be relevant mainly to countries in crisis, limiting interest to the study of historical episodes or economies with poorly developed financial markets. Consequently, many of the models used by economists to analyze usually stable, advanced economies abstracted from features of the financial sector.
This was seen as a reasonable approximation. But as we know, the recent crisis detonated in advanced economies after a long period of exceptional calm, often referred to as the “Great Moderation.” How does the economy shift from stability to crisis? While the links between the financial sector and the real economy are sometimes smooth and continuous, they can also be highly non-linear.