The first reason research on monetary economics has changed fundamentally is a set of scientific breakthroughs beginning in the 1990s. These breakthroughs involve heterogeneous-agent macroeconomics, which enables us to analyze the vast disparities in behaviors among households and firms. Only fairly recently has this breakthrough had an impact on monetary economics, not least through the class of Heterogenous Agent New Keynesian (HANK) models.  We now understand that when a central bank implements its policies there are sound empirical grounds for thinking that some households, and some firms, are not affected at all, whereas others are affected greatly. The empirical work underlying this insight uses novel micro data on households and firms. Scandinavian registry data have been crucial here. The micro data sets reveal that households’ consumption responses to shocks are not only highly heterogeneous but also suggest some departures from the key channel considered in traditional models of monetary transmission (the intertemporal substitution channel).  The traditional models used by central banks – RANK models, R for “representative” – have relied on a single type of household and a single type of firm and thus neglect the effects of heterogeneity for monetary transmission. On the one hand, these models capture many important dynamic general equilibrium aspects of the economy. In that sense, they serve policy making at central banks very well. On the other hand, they rely on mechanisms we now realize are only part (and maybe even a small part) of the whole transmission mechanism from monetary policy to the real economy. HANK models can thus be viewed as ambitious and important extensions of the traditional framework. The new models are still at an early stage of development, but research on them within the monetary-economics field is intense and broad. Central banks need to stay abreast of these developments and are currently working to incorporate HANK insights into their policy models. In the medium run we therefore expect the RANK model to be replaced by some appropriate HANK version. Another important aspect of HANK models is that they allow policymakers to better understand how inequality is affected by policy. Concerns that inequality – in incomes and wealth – is growing in an uncontrolled manner have also risen on central banks’ research agendas, especially since e.g. quantitative easing has been argued to hurt poor households while benefitting the rich.

The second reason for the drastic change in focus in central-bank research is the global financial crisis of 2007-09. The crisis had origins in the workings of financial markets, including those involving housing and mortgages.  These markets have now become a strong focus of central-bank study and monetary and regulatory policies to prevent similar crises in the future are at the top of policy agendas. Moreover, it has become clear that in order to understand the key mechanisms at work it is necessary to coordinate empirical analysis of households and firms and theoretical modeling of heterogenous households and firms. As a result of these developments, we think differently about the macroeconomy today. Macroprudential policy has become a novel policy domain. This policy branch, and its interaction with monetary policy and measures aimed at promoting financial stability, remain scientifically unexplored. Our understanding is improving fast, however, making it important for central banks to stay tightly attuned to the research frontier.

To prevent financial crises, and to understand the workings of financial markets more generally, it is also important to understand how market participants adapt their strategies in response to changes in economic, technological, and regulatory shocks. In the field of financial market structure, such micro-level analyses of the interplay of traders, investors, and intermediaries are pursued in order to understand the determinants of market quality (measured in terms of liquidity, price discovery, and resiliency). With an increasingly complex and decentralized market structure in virtually all asset classes, this field helps us understand triggers of financial frictions, bubbles, freezes, and crises.

In sum, recent research in monetary economics, macroeconomics and related empirical fields, such as household finance, has embraced heterogeneity. New theoretical and empirical strands have emerged and become central to how policy makers are beginning to think. The strong interest in these issues is reflected in the large fraction of central-bank conferences presently being devoted to research in these areas.
Turning, finally, to the role of research pursued at SU, it so happens that SU hosts a set of international leaders in these areas, with expertise in both theoretical modeling and empirical work. In particular, some of the seminal papers in the heterogeneous-agent strand of literature (including studies of monetary and financial frictions) are contributions by SU researchers.