- A new book by Jagoda Kaszowska-Mojsa challenges the suitability of traditional dynamic stochastic general equilibrium (DSGE) models for systemic risk analysis;
- Agent-Based Models (ABMs) offer superior capabilities due to their ability to capture the endogenous nature of systemic risk and the non-linear dynamics that are inherent to financial systems.
Financial Crisis driven by 'internal vulnerabilities'
Crisis and systemic risk were a significant cause of rising inequality in both the United States and the EU following the global financial crisis in 2008.
While the financial crisis in the US was driven by deregulation processes, and global current account imbalances, the crisis in EU periphery countries was predominantly driven by internal vulnerabilities - such as excessive exposure to the real estate sector, fragile banking systems, high levels of indebtedness and heightened uncertainty, which intensified cross-sector contagion.
In Financial Instability and Systemic Risk: From the Global Financial Crisis and Beyond, Dr Jagoda Kaszowska-Mojsa of the Complexity Economics programme at INET Oxford, finds that the relative role of systemic risk in EU countries was greater during the course and aftermath of the crisis than during the initial phases. This is primarily explained by the presence of feedback effects and amplification mechanisms that altered the functioning of the financial system during the crisis.
What is Financial instability and Systemic risk?
Financial instability arises when the financial system becomes fragile and less able to support the real economy — for example by providing credit, managing risk or absorbing shocks. Systemic risk is the danger that problems in one part of the system spread more widely, as distress in one bank, market or country is amplified through financial linkages and feedback effects.
The book argues that crises are not always triggered by external shocks. Fragility can also build up from within complex financial systems, as the decisions of banks, firms and households interact in unexpected ways. This is why agent-based models are useful: they allow researchers and policymakers to simulate how risks emerge, how they spread, and how different regulations may affect both stability and inequality.
"The agent-based modelling approach is evolving rapidly worldwide." Jagoda Kaszowska-Mojsa, Economic Expert at the Bank of Poland; Researcher at the Institute of Economics, Polish Academy of Sciences
Financial crisis 'exposed limitations' of traditional micro-prudential approaches
A well-calibrated macroprudential stance stabilises the economy and reduces inequality, whereas a mis-calibrated stance may lead to heightened fiscal instability and increased inequality.
But macroprudential policy design involves important trade-offs. While certain policy combinations may improve financial stability, they may also generate welfare effects and substantial changes in inequality indicators, depending on their calibration and institutional context. This makes new tools such as data-driven Agent-Based Models essential for simulating how alternative regulatory choices affect both systemic risk and redistribution across the economy.
Dr. Kaszowska-Mojsa said that certain prudential regulations in EU countries may have increased systemic risk and financial instability during the period, contrary to their intended purpose.
"The outbreak and progression of the financial crisis exposed the limitations of traditional micro prudential approaches to financial regulation and policymaking.
"In this work we looked to identify the role of systemic risk in the causes, course and effects of the financial crisis in EU countries and assess the effectiveness and optimality of the regulatory and prudential measures that have been introduced within the EU to mitigate systemic risk.
"This is an under-researched area. Developing a coherent methodological framework for the study of systemic risk and applying this to evaluate regulatory and prudential policies appears essential to address practical shortcomings in financial policymaking.
"There is growing interest globally in measuring and modelling of financial sector and systemic risk and there are urgent needs for mechanisms to assist this cause. Research on macroprudential stances should rely on agent-based approaches rather than the DSGE models, which are based on the social planner framework."
