The other branch of mainstream economics apart from the neoclassical/monetarist school are the Keynesians. They seem to have deserted the old ‘liquidity preference’ element of Keynesian theory for an explanation of this crisis, namely that money gets stuck in the financial sector as individuals hoard cash and banks do not lend it onto the real economy because real interest rates are too high.
Having condemned the failure of neoclassical school (see my post, Vulgar economics in despond, 28 May 2010 ), top American Keynesian economist Paul Krugman now prefers to draw on the causes of the crisis in Keynes’ perception of the ‘animal spirits’ of capitalists (in other words, the changes in the confidence of economic agents, consumers and business leaders, to buy, borrow, invest, or speculate).
The Keynesians have also deserted their standard ‘effective demand’ theory that argues an economic slump is due to a lack of aggregate demand in an economy and in particular, a lack of consumption. Robert Farmer is a leading Keynesian economist and adviser to various US governments. For him, the key element of a Keynesian explanation of the recent crisis can be found in animal spirits. Aggregate demand does not depend on low wages or an unemployment equilibrium but on ‘confidence’ and that is best indicated by the movement in stock prices.
Farmer does not tell us why confidence is subject to such sudden and sharp changes. It just is. A fall in confidence leads to a fall in stock prices and then to employment, consumption and investment. And the spiral continues until ‘confidence’ returns. Then stock prices rise and the whole process reverses. Thus the crisis is caused not by a lack of effective demand leading to a collapse in wages and employment, but by the lack of speculation in stock markets!
Stock markets could stay permanently in a ‘bear market’. So the answer to economic slump is not so much to provide fiscal stimulus, but for the government and the central bank to intervene through the purchase of stock market indexes to pump-prime investors and restore their animal spirits. The answer to a slump is to give money to stock market speculators!
The Keynesians have also looked to the behavioural school of economists for better explanations of economic crisis than that of Keynes. For some time, this ‘micro motivation’ approach to economics has been popular with young economists who have turned away from questions like poverty, inequality or unemployment to study behaviour on television game shows.
For example, the young economists at the Bank of England wish to tell us that such is the role of ‘uncertainty’ in economics (16) (as it is in climate change or the weather) that we must accept “sharp changes in expectations, which is exactly what happened in autumn 2008, with the sudden and synchronous collapse in business confidence around the world”.
For them, the way forward is to look much more closely at the behaviour of economic agents. There are four key aspects: 1) consumer or business behaviour can be influenced by recent or personal experience (an economic depression for example). 2) economic behaviour can depend on how the issues are presented to economic agents (like whether their pensions are assured or not) 3) people tend to follow the action of others (the herd instinct, the wisdom in crowds etc) and 4) people have excessive faith in their own judgements and wishful thinking.
Economists are thus faced with a conundrum: they need to provide guidance on the direction of an economy but such is the role of people’s expectations and uncertainty, they cannot with any degree of accuracy. Apparently “people do not often make decisions in the rational front of brain way assumed in neoclassical economics, but make decisions that are rooted in the instinctive part of the brain and thus produce herd effects and irrational momentum swings.” According to one source (17), in crises, people know the risks but irrationally decide to ignore them.
We even have behaviourists developing computer models where the idea is “to populate virtual markets with artificially intelligent agents who trade and interact and compete with each other much like real people” (18). Apparently, these computerised ‘agent based’ models let “market behaviour emerge naturally from the actions of interacting participants. What comes out may be a quiet equilibrium (neoclassical) or it may be something else.” Well, that’s helpful!
Apparently, when a model of increased leverage is developed with economic agents like computerised hedge funds, we find that instability grows, not gradually but suddenly. Thus the behaviour of market agents can lead to financial crises by the very nature of markets. This is nothing new, but just chaos or complexity theory practised in a virtual world economy.
In sum, the Keynesian economists now explain the Great Recession not as Keynes explained the Great Depression as due to ‘underconsumption’ or a lack of demand which becomes stuck. Now it is due to stock market and house mortgage speculators losing ‘confidence’ because losing confidence is inherent in the capitalist organisation of the economy.
The answer to avoiding future crises is not so much to increase government spending as Keynes argued, but to subsidise the stock market and bail out the banks. As I argued in my book, The Great Recession, this is socialism for the rich, while keeping capitalism for the poor.
17. T Koutsobina, A Keynes moment in the global financial collapse, RWE Issue no 52
18. Mark Buchanan, The social atom, why rich people get richer, get caught and your neighbour looks like you