The IMF has just held a conference of big hitting mainstream economists to evaluate the efficacy of economic theory and policy in dealing with the financial crash and the ensuing Great Recession. The title of IMF meeting tells it all: “Rethinking Macro Policy II: First Steps and Early Lessons”. Apparently, some five years after the crisis broke, the world’s leading macroeconomists (Krugman was not there) are taking their ‘first steps’ and drawing ‘early lessons’ on what happened and how to avoid another disaster in the future. It reminds me of those politicians who when faced with an avoidable calamity that has hurt many people eventually respond by saying they will start a thorough investigation into what happened and it’s early days, but eventually they will come up with proposals to ensure that “it can never happen again”.
David Romer is the Herman Royer Professor of Political Economy at University of California, Berkeley. That’s a very prestigious economics post and Romer is a leading economist and author of a standard textbook in graduate macroeconomics as well as many influential economic papers, particularly in the area of the revisionist version of Keynes’ theory, taught in most universities, namely New Keynesian economics
(see my post, https://thenextrecession.wordpress.com/2013/04/03/keynesian-economics-in-the-dsge-trap/). He is also the husband and close collaborator of the US President’s Council of Economic Advisers former Chairwoman Christina Romer.
What did he conclude from the IMF conference? Well, “the relatively modest changes of the type discussed at the conference, and that in some cases policy makers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harm….Given the record for just one country over a third of a century, the idea that large financial shocks are rare, and that we therefore should not worry greatly about them, seems fundamentally wrong….I think the right conclusion to draw is that financial shocks are likely to be both frequent and hard to predict – not just in their timing but in their form.” (http://www.voxeu.org/article/preventing-next-catastrophe-where-do-we-stand).
So Romer tells us that what he has learned is that ‘financial shocks’ are not rare but ‘frequent and hard to predict’. You don’t say! But it’s hardly encouraging to know that one of the world’s leading economists cannot tell us when and how ‘financial shocks’ can take place. Mainstream economics couches all their analysis of crises in terms of ‘shocks’ to the system, implying that the capitalist process of accumulation and the play of markets is really a stable, steady equilibrium process, but is sometimes subject to ‘shocks’ from outside (exogenous). This is what is ‘unpredictable’, like meteors from the sky (although astronomical theory can now make quite good predictions on the likelihood of a meteor hitting the earth!). So what’s the answer to these unpredictable but frequent ‘shocks’? Romer tells us that “the first approach is to reform the financial system so that the shocks that it sends to the real economy are much smaller. I do not know the answers to these questions, but it seems to me that they deserve serious analysis.” Ah! Reform of the financial system, yes. What reform? Uh, don’t know. That’s helpful.
Romer assumes that the Great Recession was caused by shocks to the financial system and it was nothing to do with the capitalist production process itself. So not only are crises caused by an outside shock, they are restricted to the financial sector in an otherwise stable system. But even in this restricted area for reform, Romer sees little progress: “Yet radical redesign of the financial system was largely missing from the conference. After five years of catastrophic macroeconomic performance, ‘first steps and early lessons’ – to quote the conference title – is not what we should be aiming for. Rather, we should be looking for solutions to the on-going current crisis and strong measures to minimise the chances of anything similar happening again. I worry that the reforms we are focusing on are too small to do that, and that what is needed is a more fundamental rethinking of the design of our financial system and of our frameworks for macroeconomic policy.” Indeed.
However, Romer’s jaundiced view was countered by other eminent economists at the IMF do. The chief economist of the IMF, Olivier Blanchard, the man who has pushed IMF thinking away from outright ‘austerity’ towards more a Keynesian ‘stimulus’ view with the IMF’s ‘correction’ on the impact of fiscal multipliers (see my post, https://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/) weighed in (http://www.voxeu.org/article/rethinking-macroeconomic-policy). Blanchard claimed that progress was being made. “Rethinking and reforms are both taking place. But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation, or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight.” By this I think he really means that we are navigating blind, as there is no theory of what direction to take! Indeed, Blanchard sums up: “There is no agreed vision of what the future financial architecture should look like, and by implication, no agreed vision of what the appropriate financial regulation should be.” No vision at all.
That brings us to George Akerlof (http://www.voxeu.org/article/cat-tree-and-further-observations-rethinking-macroeconomic-policy). Another Nobel prize winner (jointly with George Stiglitz – see below) and another professor at Berkeley. Akerlof is married to Jane Yellen, head of the San Francisco Fed and the likely successor to Ben Bernanke. Yes, it is all very incestuous! Akerlof is regarded highly as a ‘behavioural’ economist (see my paper, The causes of the Great Recession), who with Robert Shiller wrote a book that argued that the crisis was the result of uncertainty in among consumers and investors leading to unpredictable movements in ‘animal spirits’ (another Keynesian term). Shiller, by the way, recently published a book, Finance and the Good Society, in which he argues that, even after the crisis, rather than condemning finance, we need to reclaim it for the “common good” (see the interview in May 2012 (http://voxeu.org/vox-talks/finance-and-good-society). So we must be nicer to banks (see my post, https://thenextrecession.wordpress.com/2012/08/09/five-years-on/) .
But how does Akerlof view the nature of the crisis? Well “my view is that it’s as if a cat has climbed a huge tree. It’s up there, and oh my God, we have this cat up there. The cat, of course, is this huge crisis. And everybody at the conference has been commenting about what we should do about this stupid cat and how do we get it down.” But Akerlof is really quite happy with the way things have gone since 2007. He reckons that mainstream economics stood the test of the crisis by successfully advising politicians to bail out the banking system and so avoid a great depression as in the 1930s. It was this policy of ‘a finger in the dyke’ that avoided a tsunami.
All the ensuing unemployment, the collapse in investment and GDP and the sharp reduction in living standards should be balanced against this ‘success’ of saving the banks from themselves. “We should have led the public to understand that we should measure success not by the level of the current unemployment rate, but by a benchmark that takes into account the financial vulnerability that had been set in the previous boom” The trouble is that the public does not see it like that and so is not aware how clever economists have really been. “We economists have not done a good job of explaining that our macro-stability policies have been effective. There is, of course, good reason why the public has a hard time listening. They have other things to do than to become macroeconomists and macroeconomic historians (!). In sum, we economists did very badly in predicting the crisis. But the economic policies post-crisis have been close to what a good, sensible ‘economist-doctor’ would have ordered. Those policies have come directly from the Bush and Obama administrations, and from their appointees. They have also been supported by the Congress. The lesson for the future is that good economics and common sense have worked well. We have had trial and success. We must keep this in mind with policy going forward. ” So speaks the husband of the future head of the Federal Reserve.
Well, Akerlof’s former joint Nobel prize winner, Joseph Stiglitz, does not seem quite so sanguine (http://www.voxeu.org/article/lessons-north-atlantic-crisis-economic-theory-and-policy). Stiglitz makes the important point that, contrary to the economists above, the capitalist mode of production is not one of perfect stable growth occasionally hit by ‘shocks’. Stiglitz puts it:“standard models had focused on exogenous shocks, and yet it’s very clear that a very large fraction of the perturbations to our economy are endogenous. There are not only short run endogenous shocks; there are long run structural transformations and persistent shocks. The models that focussed on exogenous shocks simply misled us – the majority of the really big shocks come from within the economy.”
Stiglitz points out that after five years or more of crisis, slump and weak recovery,”in terms of human resources, capital stock, and natural resources, we’re roughly at the same levels today that we were before the crisis. Meanwhile, many countries have not regained their pre-crisis GDP levels, to say nothing of a return to the pre-crisis growth paths. In a very fundamental sense, the crisis is still not fully resolved – and there’s no good economic theory that explains why that should be the case.”
Exactly! Mainstream economics did not predict the crisis (and even denied it could happen), could not explain how the cat got up the tree and now has no clear answer about what to do about getting the cat down, short of saying that ‘it should never happen again’. Stiglitz’s explanation of the crisis and the subsequent weak recovery is better, but still flawed. For him, “some of this has to do with the issue of the slow pace of deleveraging. But even as the economy deleverages, there is every reason to believe that it will not return to full employment…. This is more than just a balance sheet crisis. There is a deeper cause: The United States and Europe are going through a structural transformation. There is a structural transformation associated with the move from manufacturing to a service sector economy. Additionally, changing comparative advantages requires massive adjustments in the structure of the North Atlantic countries.”
So the crisis is really due to the mature capitalist economies getting ‘too mature’ or past their sell-by-date. This is a view that I developed from a Marxist perspective (see my post, https://thenextrecession.wordpress.com/2012/09/12/crisis-or-breakdown/). But Stiglitz does not see that this long-run ‘structural problem’ has anything to do with a system of capitalist accumulation for a profit, but to do with the ‘switch from manufacturing to a service sector’. Really? This switch has been going on for decades as far back as 1945 – can this be the reason for the failure of mature capitalist economies in 2008?
So how do we get the cat out of the tree? Well, according to Stiglitz: “It should be clear that we could have done much more to prevent this crisis and to mitigate its effects. It should be clear too that we can do much more to prevent the next one. Still, through this conference and others like it, we are at least beginning to clearly identify the really big market failures, the big macroeconomic externalities, and the best policy interventions for achieving high growth, greater stability, and a better distribution of income. To succeed, we must constantly remind ourselves that markets on their own are not going to solve these problems, and neither will a single intervention like short-term interest rates. Those facts have been proven time and again over the last century and a half. And as daunting as the economic problems we now face are, acknowledging this will allow us to take advantage of the one big opportunity this period of economic trauma has afforded: namely, the chance to revolutionise our flawed models, and perhaps even exit from an interminable cycle of crises.”
Thus Stiglitz reckons that mainstream economics has the tools to solve recurrent crises of capitalism and make the system work ‘once we revolutionise our flawed models’. But it requires some form of government intervention that is more than just monetary policy by the Fed. Unfortunately, there is no sign that mainstream economic models are being ‘revolutionised’ or that politicians want more government intervention instead of ‘less government’. Stiglitz says that “we are beginning to clearly identify the best policy interventions for achieving high growth”. Really? I don’t see mainstream economics doing any such thing in economies dominated by the capitalist sector, which only grows if it is profitable enough.
These divisions in macroeconomics were highlighted by the recent terrible scandal of the ‘two RRs’
(see my post, https://thenextrecession.wordpress.com/2013/04/17/revising-the-two-rrs/)
over the errors and distortions in their famous paper that suggested that once public debt to GDP gets above 90% in any economy, subsequent economic growth is likely to be 2% pts lower than if the debt ratio is lower than 90%.
Carmen Reinhart and Kenneth Rogoff have now published an errata to their 2010 paper on public debt and growth, acknowledging more errors in the figures, but leaving their basic conclusion unchanged. In the errata, the two RRs correct the mean averages for growth from 1946 to 2009 that were originally criticised by Robert Pollin and his co-authors at the University of Massachusetts, Amherst. But they also argue that the corrections do not affect their most up-to-date work, which still shows a slowdown in growth when debt hits 90% of GDP. “The point is, whichever way you slice it you have lower growth rates by about 1 percentage point,” Ms Reinhart said (note not 2% pts any more). Their latest set of data, which includes more countries and more years of data, still finds a drop in median growth from 2.8% to 1.8% when debt hits the 90% threshold. In response, the HAP authors wrote a new criticism point out that these median figures were also affected by the same error. Pollin says he accepts that there are different ways to weight the numbers but a conclusion should be robust. “The two RRs results are entirely dependent on using their particular methodology”. And so it goes on.
You can see why this debate has become so intense. The Austerians have used the two RRs data to ‘prove’ that austerity is necessary to get debt down and restore economic growth. Now the Keynesians are triumphant that the evidence has been ‘proved’ false. When I wrote about this before, I pointed out that there were other papers that reached similar conclusions to the two RRs, namely that high debt will lead to lower growth. But the BIS paper covered not just public debt but also private debt, as did the IMF paper. And that’s important, because it makes sense that high corporate debt will have a dampening effect on corporate investment, the key driver of growth in a capitalist economy. Public debt does not have the same direct effect, although ot can lead to increased taxation on profits and eventually ‘crowd out’ lending to the private sector by driving up interest rates – although this does not apply right now.
And of course, the issue of causality remains unanswered: does high debt lead to low growth or is it vice versa? So does the cat get in the tree because the ladder of credit gets it up there and then it can’t come down when the ladder of the credit falls over. Or is that the cat got up the tree and the ladder of credit had to be extended too far and then fell over, so the cat could not get down? Either way, the cat is still up the tree. Maybe we should just cut the tree down.