Financial innovation is not alway good for economic progress

What is it about?

In the last decade, complexity economics has emerged as a powerful approach to the understanding of the most relevant factors influencing economic development. The concept of economic complexity has been applied to the study of different economic issues such as economic growth, technological change and inequality. This work represents a first step towards the application of this concept to the study of the financial side of the economy, and particularly of the macroeconomic effects of rising financial complexity. In this paper, we present an agent-based macroeconomic model including an increasingly complex financial sector, characterized by the presence of Collateralized Debt Obligations with different seniorities next to more standard assets, like bonds and commercial papers. Simulations results suggest that financial complexity exerts major economic effects: while financial engineering makes securitized loans very attractive and opaque assets, the disperse interaction among different agents and financial institutions generated by these complex financial instruments shapes the behavior of the economies and allows for the diffusion of financial distress.

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Photo by Markus Spiske on Unsplash

Photo by Markus Spiske on Unsplash

Why is it important?

This paper provides the first attempt of modeling the "production" of complex structured financial products such as CDOs, and to show the likely macroeconomic-wide effects of this activity.