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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