Criticisms of the Dominant Paradigm and Emerging Theoretical Explorations in the Context of the Increasing Importance of Financial Stability

In this study, the aim is to focus on the rising criticisms of the dominant macroeconomic paradigm and the search for new theoretical approaches in the context of the increasing importance of financial stability. Successive episodes of financial instability, including the 2008 global financial crisis and the losses they have caused, have led to heightened criticism of the fundamental assumptions and models of the dominant paradigm. The traditional stabilization tools of the dominant paradigm, particularly monetary policy, as well as fiscal policies, have failed to prevent financial instability. However, dynamic stochastic general equilibrium (DSGE) models, built upon efficient markets, rational expectations, ergodic time, and the transversality condition, have also been subject to serious criticism. The insufficient inclusion of financial markets in these models has led to an inability to foresee financial instabilities. Models that exclude financial friction and rely on representative (homogeneous) agents have made it difficult to analyze vulnerabilities originating from financial markets and the losses they cause. In this context, in addition to the increasing importance of implementing macroprudential policies aimed at ensuring financial stability, there is also a focus on model structures that take into account financial frictions and heterogeneous agents. As a conclusion, it is argued that the new policy design, which involves the simultaneous use of monetary, fiscal, and macroprudential policies, will yield effective results in terms of macro-financial stability. However, it is emphasized that model structures incorporating financial frictions and macroprudential policy tools provide effective results in forecasting financial instability and minimizing its costs.