What Hahn’s bit of rhetoric does suggest is that you need some sort of financial friction – some departure from the platonic realm of Arrow-Debreu – to explain why money might matter. Take, for example, the relationship that determines consumer spending in many models of the macroeconomy. Typically, this originates with a question: how would a forward-looking consumer, able to borrow and lend relatively freely, allocate his or her spending over time? After solving that stylised problem, and a bit of manipulation, you end up with something like this:  [1] Here, in what I’ve described rather grandly as equation [1], f(.) is some function of current and future (real) interest rates and the term in brackets is total wealth. Wealth has two components: net financial assets W (with an average real price p) and the present value of current and expected future labour income, or “human wealth” H. (In this set-up, greater “consumer confidence” can be thought of as a rise in those future expected incomes, and therefore this H term.) Higher real interest rates depress both p and H because they increase the rate at which future income is discounted. Because there’s only one market here (in borrowing and lending) the demands of this set-up aren’t quite as onerous as in Hahn’s “best developed model of the economy”, with its multiple barter exchanges. Nor do you have to assume that people can borrow and lend at precisely the same rate of interest (it does matter that they can do so at all).
The second question raised today is: What were the reasons for undertaking steps for financial sector reform? The recent financial crisis served as a reminder that the impaired financial system can have a significant impact on the functioning of the overall economy. Moreover, the 2007–08 financial crises was, to a great extent, a result of the failure of public authorities in the United States and Europe to adequately monitor and address systemic risk. By comparison, Asia and other parts of the world where memories of systemic financial crises were still fresh, had adopted more prudent policies and practices, and were less impacted by the subprimetriggered financial shockwaves. In order to make global finance more stable, the 2009 G20 summits in London and Pittsburg listed commitments on financial regulatory reform, pushing the financial regulation to the forefront of the global economic cooperation agenda at the level of political principles, which had until then, been mainly focused on trade and macroeconomic policy. The items on regulation can themselves be divided into two subgroups. On the one hand, the G20 decided to tighten or strengthen the regulatory framework applying to entities or activities that had already been regulated before the crisis.