What a load of Bollocks

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Two prominent economics textbook writers have recently written that the Global Financial Crisis (GFC) shows that the world needs more economics rather than less.

Writing in the New York Times, Gregory Mankiw could see some need to modify economics courses a bit in response to the GFC, but overall he felt that:

“Despite the enormity of recent events, the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses.” (That Freshman Course Won’t Be Quite the Same, New York Times May 23 2009)

Writing on a blog The East Asia Forum, authors Doug McTaggart, Christopher Findlay and Michael Parkin wrote that:

“The crisis has also brought calls for the heads of economists for failing to anticipate and avoid it. That idea, too, is wrong: much economic research pointed to the emerging problem.

More economic research (and teaching), not less, is the best hope of both emerging from the current crisis and of avoiding future ones.” (The state of economics, East Asia Forum, May 21 2009)

What a load of bollocks.

The “principles of economics” that Mankiw champions, and the “More economic research (and teaching)” that McTaggart et al are calling for, are the major reason why economists in general were oblivious to this crisis until well after it had broken out.

If they meant “Principles of Hyman Minsky’s Financial Instability Hypothesis”, or “More Post Keynesian and Evolutionary economic research”, there might be some validity to their claims. But what they really mean is “principles of neoclassical economics” and “More neoclassical economic research (and teaching)”–precisely the stuff that led to this crisis in the first place.

Neoclassical economic theory supported the deregulation of the financial system that helped set this crisis in train. See for example this New York Times report on the abolition of the Glass-Steagall Act in 1999 “CONGRESS PASSES WIDE-RANGING BILL EASING BANK LAWS” (New York Times November 5th 1999).  The reporter Stephem Labaton noted that:

The opponents of the measure gloomily predicted that by unshackling banks and enabling them to move more freely into new kinds of financial activities, the new law could lead to an economic crisis down the road when the marketplace is no longer growing briskly…

Then he observed that

Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.

This is a very apt description of the role of neoclassical economists over the last 40 years: every step of the way, they have argued for deregulation of the financial system. Now we have McTaggart and colleagues making the self-serving claim that:

The current crisis is a failure of regulation that calls for not more regulation, but the right regulation.

So the same economic theory that supported the abolition of Glass-Steagall, amongst many other Depression-inspired controls, is suddenly going to be able to do a volte-face and tell us what “the right regulation” might be? Garbage.

What is really needed is a thorough revolution in economic thought. First and foremost this has to be based on empirical reality, and from this perspective almost everything that current textbooks treat as gospel truth will end up in the dustbin.

Coincidentally, many non-neoclassical economists whose writings have been put into the dustbin by today’s economics orthodoxy will be back on the shelves once more. Minsky, Schumpeter, Keynes, Veblen and Marx don’t rate a mention in in most current economic textbooks; they had better feature in future texts, or by 2060 or so we’ll be back here again.

Though I’m clearly annoyed at Mankiw’s and McTaggart’s drivel, I’m not surprised by it–in fact I predicted it (I doubt that they can point to anything they wrote prior to the GFC that predicted it!). I said the following in an article “Mad, bad, and dangerous to know” published on March 12 2009 in issue 49 of the Real World Economics Review:

Despite the severity of the crisis in the real world, academic neoclassical economists will continue to teach from the same textbooks in 2009 and 2010 that they used in 2008 and earlier…

they will interpret the crisis as due to poor regulation,…

They will seriously believe that the crisis calls not for the abolition of neoclassical economics, but for its teachings to be more widely known. The very thought that this financial crisis should require any change in what they do, let alone necessitate the rejection of neoclassical theory completely, will strike them as incredible.

Sometimes, I would like to be wrong…

Finally, what lesson did neoclassical economists take from the Great Depression? That the Federal Reserve caused it via poor economic policy. Who do current neoclassical economists blame for this crisis? The Federal Reserve of course, for poor economic policy: 

By 2007, fuelled by the Federal Reserve’s egregious policy errors, markets were moving into unsustainable bubble territory. The Fed by this time had realized the problem was getting out of hand and had moved interest rates up sharply—too sharply—and burst the house price bubble. (McTaggart et al).

But who staffs the Federal Reserve? Neoclassical economists of course…

Please, let’s not fall for this nonsense a second time. Keynes tried to free us from neoclassical economic thinking back in the 1930s, only to have neoclassical economists like John Hicks and Paul Samuelson eviscerate Keynes’s thought and re-establish a revitalised neoclassical economics after the Depression was over. This time, let’s do it right and get rid of neoclassical economics once and for all.

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185 Responses to What a load of Bollocks

  1. ak says:

    Aac,

    This is a different story. The principle will be paid back to you.

    I think that what he wrote about was that the government can for example buy work from my wife (who works for the public sector) by crediting our bank account and there is no need to borrow money for that by selling bonds or extract money from other people by collecting taxes.

    In that case the spending will not be covered by borrowing / taxation and the amount of M1 will increase.

    Now the key point:
    Under certain circumstances this may lead to inflation but under other circumstances this will not lead to inflation.

    Could Steve comment on this if I am wrong?

  2. ferb says:

    Iconoclast

    “That is the elite have skewed the system, via neo-liberal economic policies, to lay greater and greater claim to the output of the economic system, forcing the middle and low economic strata of society to be forced to take on further and further debt as an attempt to maintain their living standards.”

    Define standard of living now days?

    The elite you refer to are the banks and the “output” is the credit default swap/derivative market.

    However, these people who have screwed the system would not have been able to had it not been for the market of middle and lower socioeconomic classes who went on a 5 yr rampage of sub-prime and easy credit. These people did the greedy thing and took anything they could “to get ahead”, or get closer to retirement.

    Meanwhile the elite made huge gains on the output of the derivatives until people started losing there jobs and defaulting.

    Yes, society has been forced to take on more and more debt, and i would argue did not manage to maintain there living standards (1/16th acre block anyone?). However, it’s just as much there own silly fault for being just as greedy as the wall st banker.

    I think you need to analyze the role that society as a whole is responsible for there own demise – regardless of elite status.

  3. Aac says:

    ak said
    “I think that what he [oconoclast] wrote about was that the government can for example buy work from my wife (who works for the public sector) by crediting our bank account and there is no need to borrow money for that by selling bonds or extract money from other people by collecting taxes.”

    Uh, if the money was conjured out of thin air and does not need to be paid back then that’s outright printing. Note, I said “if” as I’m not 100% sure you meant money out of thin air.

    One of the most fundamental and trivial points of how things work is being discussed and no one can explain it in plain and concise English. For the benefit of readers, here’s how I am certain it works. People please correct where you think it’s wrong.

    If the gov sells bonds to person P and the gov then spends the proceeds then the amount of money in the system has not changed. However X amount of goods have been purchased that otherwise may not have been as person P may have chosen to leave it in the bank and the bank may not have been able to lend it out. This seems like a straight forward loan. Another point is that the bonds (AAA of course) can be used as collateral by person P and if person P is a bank then those bonds would be part of Tier 1 capital. Thus not only has X amount been spent by the gov but there exists X amount of capital. It all reverses at maturity of course when the gov pays back the loan. Thus deficits create credit inflation which like I have stated is inflation that exists over the period of the loan – ie. temporary inflation.

  4. ak says:

    Aac,

    “Uh, if the money was conjured out of thin air and does not need to be paid back then that’s outright printing. Note, I said “if” as I’m not 100% sure you meant money out of thin air.”

    There is nothing wrong with this process itself but under certain circumstances side efefcts may not be good.

    Please read this:
    http://bilbo.economicoutlook.net/blog/?p=2562

    The distinction between the old commodity-based money system and the fiat money system is clearly described in that article.

    You may or may not share some of the author’s views about what should be done but you should accept the facts described there. It is written in plain English.

    Regarding your example I think it refers to fractional banking system where it is assumed that banks act as money multipliers. Which is how the neoclassical economists describe the reality – but they are wrong.

    Please read this:
    http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

  5. Bullturnedbear says:

    Hi Aac,

    Don’t take from my comments that I am taking sides in your debate with Icon. Half the time I can’t tell what your debate is about.

    On your point about Tier 1 capital. You have some misinformation. I know that it is irrelevant to your debate, so let me correct you for arguments sake.

    Tier 1 capital is purely to do with the amount of equity a bank has raised from selling its own stock. ie, IPO or capital raisings. On top of this, tier 1 capital can grow if a bank makes and retains profits. Tier one can fall if a bank makes losses or pay out a dividend. Tier 2 capital is largely explained by preferred stock. Which I think is crap. Because preferred stock is really a loan and should not be counted as capital. Anyway that’s the rules.

    The whole system is meant to capture the health of banks. What a load of crap. I believe the health of a bank should be measured by its reserve ratio. Reserve ratio is a better measure because it reflects how much a depositor’s money is at risk. Reliance on a capital ratio assumes that in tough times a bank can simply sell assets (securitise loans) or raise capital (sell fresh stock) to “fill the gaps”. As Oct/Nov ’08 proved. In tough times a bank may not be able to do either of these things.

    To a bank Government Bonds are an asset. That is, a loan to the government. They are considered to be a safe asset and as such are risk weighted zero (excluded) when measuring the capital ratio, but they are not capital. As a further example, a home loan is 50% risk weighted and a commercial loan is 100% risk weighted.

    Government bonds are considered to be reserves, because they can quickly be sold, thus converted to cash and returned to depositors should they want some of their money back.

  6. ak says:

    This is also good as a masterpiece of propaganda art rivalling only pieces from late 1980-ties from the Soviet bloc:

    http://www.news.com.au/business/story/0,27753,25567306-31037,00.html

    “China is the largest single purchaser of US Treasury debt and already has shifted investment of some of its reserves to shorter-term maturities, a sign that it may fear the US will be forced to push interest rates up to control inflation when recovery begins.”

    What recovery? Obviously there is no private debt problem there so they are very close to recovering after their banks passed the stress test. Back to normal?

    The Chinese are aware I think that the US economy has to be put on a life support for at least several years. Since USD is not only the US domestic currency but also the international currency the US government will print money to buy oil and products overseas. They will also print money to buy back the bonds from China as they will be unable to roll them over. They will never be able to repay the debt by exporting more goods than they import as the real industries producing goods have been replaced by the FIRE industry. The deeper they sink into recession the more the productive industries (like car manufacturing) suffer. So if they stop printing now they will sink even deeper. This is the real catch 22 for them.

    I would say there are 2 money circuits there – the national one (still suffering from deleveraging and depression) and the international one. I don’t think that there will be domestic pull inflation in the US for the reasons stated by Steve.

    I do believe USD is being dumped as the international currency and US bonds as safe investment instrument. Nobody likes getting freshly “printed” USD not backed with any real goods.

    The US will eventually recover but they have to eat the humble pie first.

  7. iconoclast says:

    ferb,

    In part, your point is germane, the blame can be apportioned throughout society, for there can not be a valley without a hill. However, it is unassailable that the blame is very heavily biased towards the upper echelon.

    It is the wealthy corporate elites that systematically lobbied for changes to statutes of law and to regulations that were in place to temper irrational forays of the past. It’s not as if we haven’t been here before. It is their ideology and their penchant support of neo-liberal voodoo gibberish that has created this disaster.

    I would have something to say about the other points you have made, which I don’t agree with. I would prefer to provide a far more detailed synthesis of my position, unfortunately, at present, time does not permit.

  8. ferb says:

    “It is the wealthy corporate elites that systematically lobbied for changes to statutes of law and to regulations that were in place to temper irrational forays of the past.”

    Ah, actually only partly.

    If you read into history you will see that it was the progressive left and Clinton who got together and devised a great idea to make property ownership more accessible to the masses.

    http://www.nytimes.com/1999/09/30/business/fannie-mae-eases-credit-to-aid-mortgage-lending.html

    The important point – this was government quasi-intervention into the market, lobbied by private entities for obvious gains. The Government had a chance to recognize the neo-liberalism at play, and stop it before…and i quote

    “In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s”

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