The Tiger’s lair – HETSA Conference, July 2011.
It is an honour to be speaking at this meeting of the History of Economic Thought Society Australia (HETSA) at RMIT University. My recent visit to the economists of ANU was like entering a Lion’s den, and this feels a bit like visiting a Tiger’s lair.
My circulated paper is based on Chapter 11 of Great Crises of Capitalism and is titled ‘Great Crises of Economics – what are the lessons’. Here is a link to the full presentation.
My perspective is that of a policy advisor and ‘how does the economy work’ is a vital matter for such a person. I was a serious policy oriented researcher for 10 years and a real live policy advisor for another ten. You might see me as a Rip Van Winkle figure, but for the past 20 years I have not been asleep, merely distracted from time to time.
Today my time is limited, so I shall pull out of the presentation some key points. I hope to provoke fruitful discussion and perhaps find a collaborator or two willing to tackle one or more of the unresolved issues.
Let me start with a controversial statement, from the start of Chapter 12 of Great Crises of Capitalism:
Episodes of collective over-optimism or mania always end in a crisis in which great damage is done to whole economies, and to many individuals and families. There is thus an understandable desire among governments to head off such episodes so as to prevent the costly aftermath. After all, periods of costly correction may coincide with elections, and governments are likely to be judged responsible, even if only in part, and will be punished at the polls.
This is the ideology of modern democratic governments in capitalist nations, but I believe it to be wrong. It is wrong for at least two powerful reasons. The first is that it may not be possible, probably is not possible, to prevent episodes of economic euphoria. Trying to do the impossible is a recipe for failure. Attempts to do the impossible may be heroic but are seldom sensible, and do little for a government’s reputation with its voters
The second reason to question current beliefs is that periods of boom lead to great achievements, and the inevitable crash punishes most of the dishonest and the incompetent players. Stifling the booms will remove or reduce the possibility of great achievements. This will damage the inherent dynamism of capitalism. Clearly, however, society can and should have in place mechanisms to help the more or less innocent bystanders. A civilised nation must not stand by and watch people starving to death, or forced to entertain criminal acts to feed themselves and their families – both features of Melbourne’s Great Depression of the 1890s. Welfare is costly, and its presence blunts incentives, so there is a careful balance needed here. Some economists, including this writer, believe incentives have already been blunted too much in modern capitalist societies by high rates of tax and welfare payments.
Key analytic points are as follows
1. Any adequate portrayal of the modern economy must recognise demand and supply in a myriad of markets both within countries for non-traded goods and services (a vanishing set) and between countries, which ultimately means globally. Expectations of the players are important but hard to understand or allow for, and confidence of key participants is vital but difficult to influence except negatively.
I am reminded of modern physics with its many particles (or strings) whose laws can only be inferred by complex experiments and hard thinking. Economics is inherently more difficult as the individual economic entities think for themselves and have free will, or at least that is what most of us believe.
2. It is the assumption about market clearing that most clearly divides economists interested in economic history, theory, modelling or policy. Neo-classical economists deny any market fails to clear but consider assumptions of imperfect information or mistaken expectations to justify lagged adjustment. But there is a school of economics – based on simple facts – that asserts that economies develop irrational financial instability, with runaway asset and credit inflation followed by a reaction that leaves many resources unemployed or underemployed. [Eiffel tower analogy.]
3. Keynes grappled with the causes of the Great Depression and enthroned ‘affective demand’ as the major culprit. He might just as well said the problem was lack of ‘effective supply’, but his emphasis on ‘Animal spirits’ might just eventually be seen as his greatest contribution. The problem of course is that ‘animal spirits’, or the ‘state of confidence’ can be invoked to explain just about anything.
4. Among the post-Keynesians, I like Minsky’s approach, especially its notion of ‘Tranquillity’ rather than ‘equilibrium’ between bouts of over-optimism and the effects of conventional financiers reducing credit standards or innovative financiers finding new ways to expand credit during booms. This is a major part of the Melbourne land boom of the 1880s, the American boom of the roaring Twenties and the ‘subprime’ boom of the 2000s.
I am assured by Steven Kates that his new book argues that there is no equilibrium in any time period. This idea sounds good to me except that there are various constraints that limit the degrees of freedom and therefore may define equilibria, or at least a corridor.
5. Furthermore, I do not believe that economists have ‘nailed’ the reason why the asset bust of the 1930s led to a Great Depression whereas many other asset busts did not. This is a vastly important matter, as there is a marked tendency in the historical record for asset booms and (the inevitable) asset busts to become more frequent and larger.
6. The lack of a Great Depression following the crisis of 2007 – 08 does not prove the success of Keynesian policies. The crisis is not yet over and the Eurozone and US debt crises are yet to be resolved. Like the French revolution, it is far too soon to say there will be no great depression.
7. The policies followed in the state of panic in 2007-08 are best described as temporally and logically inconsistent.
• Zero interest rates in the USA, exporting inflation.
• Massive fiscal stimulus, replaced a short period later by deep concern at rising debt burdens.
• The bailouts of most failed financiers but not Lehman Bros, producing financial sector gridlock.
These inconsistent policies in fact were the key reason that I wrote Great Crises, and I obviously believe with Keynes that ‘mad persons in authority’ need to reconsider their theories of how economies work.
8. ‘Inflation is always and everywhere a monetary phenomenon’ as Milton Friedman famously said. The quantity theory equation MV = Py is best interpreted as an equilibrium, and my own theoretical and empirical analysis as a young economist focussed on ‘monetary disequilibrium’ as a key driver of economic fluctuations. But Py of course is a vector. Add a ‘China effect’ holding down consumer goods prices and excess money may show up largely in asset prices. Creatively recasting Friedman’s theory in vector form might be a very influential bit of economic analysis with great contemporary relevance.
9. Inflation of various commodity and asset classes has become the norm since President Nixon abandoned the final vestiges of the gold standard in 1971. Reform of global monetary policy is badly needed and the most controversial conclusion in my book is that the world needs a more rules-based global monetary policy, and the best candidate for this is a modern version of the gold standard. I also propound a set of reforms to financial regulation and remuneration practices.
10. Most generally, I say that economic policy needs less ‘inspired’ discretion and more use of rules-based semi-automatic policy variation. Stable, well understood rules for economic policy will help create stable decisions by individuals and companies. ‘No surprises’ all round. I have learned from presentations at the conference that I am a Meadeian and/or a Robbinsonian.
11. There are some deeper conclusions that emerge from the study of capitalism’s great crises. I list these for discussion if you wish.
• Western nation consumerism has gone too far. How can we ask the Chinese, Indians and people from other developing nations to limit the development the current leading nations adopted so enthusiastically?
• In the financial system especially, self interest has become too dominant. It is desirable to get people to return to valuing the ‘good opinion of one’s fellows’ ahead of competing mainly or only for financial wealth – even if you disagree, this is far easier said than done.
• Asst and goods and services inflation is a great scourge and needs to be controlled – hence my modern gold standard idea.
12. Thank you for listening. I welcome your comments and questions.