Financial Crisis Research at the University of Missouri Professor by Chris Otrok

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https://coas.missouri.edu/news/mu-professor-secures-nsf-grant-develop-new-economic-model

MU Professor Secures NSF Grant to Develop New Economic Model

Professor Christopher Otrok

University of Missouri Professor Chris Otrok, the Sam B. Cook Chair in Economics, wants to know what factors led to the Great Recession of 2007 and whether this information could help predict future financial crises.

Otrok recently was awarded a three-year, $280,000 grant from the National Science Foundation (NSF) to better understand the sources of financial crises and develop policy responses to those events.

“It will allow us to think about how we should set policy, not when these events are occurring but rather when they might occur in the future,” Otrok says. “So that’s key – to think about what happens in a crisis state and how to get out of it, but also what policies we should be setting when we are not in a crisis, but it looks like there might be one brewing.”

Otrok says that economic analysis of macro-financial crises has developed in stages. Positive economic models, which he calls first-generation models, try to explain how financial frictions could cause business cycles, crashes, and recessions.

The second generation of models, which Otrok helped develop in the mid-2000s, are what he calls normative analysis models. He says they took the same models people were using for positive analysis and asked, “What kind of policies would be useful?” But Otrok says these second-generation models, like the first-generation ones, provided theoretical results that were not applicable to specific events such as the 2007 financial crisis.

Otrok will use funding from the NSF grant to develop a third generation of economic models that combine positive and normative analysis models.

“It’s going to allow us to ask the questions, ‘What actually did cause the Great Recession? What are the shocks?’ At the same time it’s going to allow us to do policy analysis in real time, not in theory,” Otrok says.

He says the new economic model will allow economists to do historical analyses, so they can try to determine what caused the 2007 crisis and analyze what policies might have prevented the crisis or lessened its impact.

In fact, Otrok says he will use historical data based on a series of financial crises in Mexico in the 1990s to develop the new model, which will then be used to analyze economies in real time.

“So with the new model I would not say, ‘There will be a crisis tomorrow.’ I would say there is a probability of a crisis, and I would give you some range of probabilities, and when that range gets high, then you should start to worry,” Otrok says.

Otrok is a research fellow at the Federal Reserve Bank of St. Louis and coordinating editor of the Journal of Economic Dynamics and Control.

His studies focus primarily on macroeconomics, international macroeconomics, and Bayesian econometrics.

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