Why did the stock market boom during a pandemic that killed millions of people?
Background
Before 2008, mainstream macro models treated financial markets as a sideshow -- efficient intermediaries that allocated capital without friction. The crisis forced a rethink. Financial frictions, leverage cycles, and systemic risk are now central to macro research and policy.
The practical implication is that monitoring financial conditions is as important as monitoring inflation and output. Financial stress can arrive faster than traditional macro indicators can detect it.
What it covers
Financial markets allocate capital, price risk, and provide liquidity. When they function well, they channel saving to productive investment. When they malfunction -- through excess leverage, asset bubbles, or contagion -- the damage spills into the real economy through credit crunches, wealth destruction, and confidence collapse.
The financial accelerator (Bernanke, Gertler, Gilchrist 1999) describes how financial frictions amplify real shocks: falling asset prices erode collateral values, which tightens credit, which reduces investment and output, which further depresses asset prices. This feedback loop can turn a moderate downturn into a deep recession.
Open question
Are financial conditions supporting or threatening the real economy, and are the vulnerabilities systemic enough to warrant macroprudential intervention?