What Janet Yellen—And Almost Everyone Else—Got Wrong

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I was delight­ed to see, in Paul Krugman’s post – ‘What Janet Yellen – And Every­one Else – Got Wrong’ – that he now iden­ti­fies ‘the debt over­hang’ as the rea­son this eco­nom­ic down­turn has per­sist­ed for so long.

The best expla­na­tion, I think, lies in the debt over­hang. For the most part, even those who cor­rect­ly diag­nosed a hous­ing bub­ble failed to notice or at least to acknowl­edge the impor­tance of the sharp rise in house­hold debt that accom­pa­nied the bub­ble. And I would argue that this debt over­hang has held back spend­ing even though finan­cial mar­kets are oper­at­ing more or less nor­mal­ly again. In short, get­ting the bub­ble right, while no small thing, wasn’t enough; Yellen (and many oth­er peo­ple, myself includ­ed) under­es­ti­mat­ed the fragili­ty of the finan­cial sys­tem, but also the impor­tance of house­hold debt.

This is progress: econ­o­mists are start­ing to acknowl­edge the impor­tance of pri­vate debt in macro­eco­nom­ics. There’s just one fea­ture of his post I’ll quib­ble with: the propo­si­tion that “Yellen and Every­one Else” got this wrong before the cri­sis. There was at least one econ­o­mist who did get it right, and who did so long before the cri­sis erupt­ed.

He was Arthur Cecil Pigou, and–in the spir­it of Krug­man’s  (‘Non-prophet Eco­nom­ics’), that “we should first of all be eval­u­at­ing mod­els, not indi­vid­u­als… we’re look­ing for the right eco­nom­ic frame­work, not the dis­mal Nos­tradamus”, then Pigou clear­ly gave us the right eco­nom­ic frame­work, two years before the cri­sis began. In 1927, to be pre­cise.

Read more: http://www.businessspectator.com.au/article/2013/8/16/economy/urgent-debt-lessons-forgotten-framework#ixzz2c8FjS7kZ

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.