Blanchard and Summers: Back to the future?

Olivier Blanchard and Lawrence Summers has recently called for a reflection about the macroeconomic tools required to manage the outcomes of the 2008 global crisis  in their paper Rethinking Stabilization Policy. Back to the Future. The relevant question they address is: Should the crisis lead to a rethinking of both macroeconomics and macroeconomic policy similar to what we saw in the 1930s or in the 1970s? In other words, should the crisis lead to a Keynesian approach to macroeconomic policy or will it reinforce the agenda suggested by mainstream macroeconomics since the 1990s?

Since the 1990s, mainstream macroeconomics has largely converged on a view of economic fluctuations that has become the basic paradigm of research and macroeconomic policy. According to this view of unexplained random underlying shocks, the fluctuations result from small shocks to components of demand and supply with linear propagation mechanisms which do not prevent the economy to return back to the potential output trend.  Considering a world of regular fluctuations:  (1) dynamic stochastic general equilibrium (DSGE) models are used to develop structural interpretations to the observed dynamics, (2) optimal policy is mainly based on monetary feedback rules- such as the interest rate rule- while fiscal policy is avoided as a stabilization tool, (3) the role of the finance is often centered on the yield curve, and (4) macro prudential policies are not considered.

As the real-world of financial crisis does not fit this representation of fluctuations, Blanchard and Summers, following the influence of Romer’s reference of the DSGE regular shocks as phlogistons, assess that the image of financial crises should be “more of plate tectonics and earthquakes, than of regular random shocks”. And this happens for a number of reasons (1) financial crises are characterized by non-linearities that amplify shocks (for instance, bank runs), (2) one of the outcomes of financial crises is a long period of depressed output followed by a permanent decrease in potential output relative to trend as the  propagation mechanisms  do not converge to the potential output trend,  (3) financial crises are followed by “hysteresis” either through higher unemployment or  lower productivity,  .

Almost ten years after the 2008 crisis, among the current “non-linearities” that led to the current deep policy challenges, Blanchard and Summers also highlight

  • The large and negative output gaps in many advanced economies,  in addition to low growth, low inflation, low nominal interest rate, reduction of nominal wages in advanced economies,
  • The interaction between public debt and the banking system, a mechanism known as “doom loops” since higher public debt might lead to public debt restructuring that might turn out to decrease the level of banks’ capital and, therefore, this situation might increase concerns about their liquidity and solvency.

Considering the current policy challenges, they suggest to avoid the return to the pre-crisis agenda or even to avoid the adoption of what they call “more dramatic proposals, from helicopter money, to the nationalization of the financial system”. In their view, there is the need to use macro policy tools to reduce risks and stabilize adverse shocks. As a result, they suggest:

  • A more aggressive monetary policy, providing liquidity when needed.
  • A more active use of fiscal policy as a stabilization macroeconomic tool, besides a more relaxed behavior in relation to fiscal debt consolidation.
  • A more active financial regulation.

Interesting to say that Blanchard and Summers mention the importance of Hyman Minsky in warning the special role of the complexity of finance in contemporary capitalism. However, in the defense of their proposal, they should have remembered the Minskyan concern:  Who will benefit from this policy agenda?

Any policy agenda  refers to forms of power: there are tensions between private money, consenting financial practices and national targets that emerge in the context of  the neoliberal global governance rules.

Indeed, almost ten years after the 2008 global financial crisis, it is time to rethink the contemporary political, social and economic challenges in a broader context and in a broader and longer perspective.  Power, finance and global governance are poweful interrelated issues that shape livelihoods.

  1. David Chester said:

    What a lot of old cobblers! The basic cause of the 2008 financial crisis which occurs with surprising regularity every 18 years, was due to speculation in land values which grew until the bubble burst and it was no longer worth while to hold mortgages even with the “cheep money” the banks happily provided.

    Before developing these somewhat elaborate theories about blaming it on money you should really become acquainted with the Georgist School of land speculation theory and their remedy of land value taxation (which the landlords will fight tooth and nail to oppose). In case you are unaware of this theory I suggest you look up some more about Henry George and the fairly recent explanation given by Professor Mason Gafney and Fred Harrison in “Boom-Bust!” which reached 3 editions.

  2. Maria Alejandra Madi said:

    Thanks for your comment. Speculation is not considered in the DSGE models! even the suggestion of Blanchard and Summers do not consider that a more expansionary monetary policy will continue to nurter asset bubbles


  3. For me it’s greatly frightening to see such ignorant people claiming the role as guardians of the welfare of not just individuals but entire nations. Like video games, theories and models can be fun. But they are never a substitute for detailed and objective study of the actions and decisions of people, all kinds, and flavors of people. Some you love, some you hate. They all have part of the story of how society works, including economics. It requires an extreme level of ignorance combined with arrogance to prefer theories and models (mathematical and otherwise) over the inventors of our ways of life. Social scientists and historians know this is their job. Sometimes they get lost in the minutia, but they always come back to the work of concrete actors in concrete situations. A while back economists became entranced by wealth and power, and by their own supposed infallibility. They left the path of science. This is, succinctly why they should not have the role of “expert” in policy making or public debate. They like to play with models. Give them a play pen. The description here of some economists clawing their way back to science is not enough to change my conclusion.

  4. Maria Alejandra Madi said:

    Dear Ken,

    Great comment! I agree. The scientific proposal of Blanchard and Summers lacks the reference to concrete actions and concrete actors. That is why it does not cope with the complexity of current economic and political challenges. Maria

  5. Wisslyon said:

    Maria, You have to look beyond academic rhetoric. You have to look at the facts. You assume that mainstream macroeconomics has been controlling economic policy since 1990s. This is false. Mainstream macroeconomics has been dominant in academic research mainly to justify neoliberalism or economic rationalism or neoclassical economics in the deregulation of financial markets.

    However, in government policy of fiscal and monetary stimulus. Keynesian economics has never had more dominant influence in reality for development countries for past decades. For example, the US has had persistent fiscal deficits for decades as Keynesian economic stimulus, now reaching four to ten percent of GDP. Neoclassical economics would have put an end to that. France has now government expenditure at 50 percent of its GDP. Governments, not markets, dominate macroeconomics.

    Blanchard and Summers are advisors who led us to the global financial crisis. Summers was a main force behind the repeal of Glass-Steagall which allowed systemic fraud from financialization – the main cause of the now observed wealth inequality, not capitalism which respects private property and does not approve theft or confiscation of private property.

    A very thorough study leading to my opinion can be found here e.g. on fiscal stimulus:

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