Advanced Macroeconomics II – Spring 2019 – PIDE – Dr. Asad Zaman. Course Website: https://bit.do/az4macro . Lecture 9 is provides an introduction to L Randall Wray “Why Minsky Matters”. This post [L09A] covers the first portion (00-27:22m) of the lecture linked in the YouTube Video Below:
AM2 L09A – first half of lecture 9 compares the Global Financial Crisis to the Great Depression, similarities in origins and differences in responses.
- Why did No One See It Coming?
We start by posing the question “Why did no one see it coming?” which the Queen of England asked at the London School of Economics. To answer, we must consider the evolution of macroeconomic thought. This involves the rejection of Keynes, the rise of monetarism of Friedman, the extremism of Lucas, New Monetary Consensus of Bernanke, Efficient Markets of Fama, Laissez-Faire approach to financial regulation. The book starts with a beautiful description of the problem, eminently worth adding to my collection of “Quotes Critical of Economics”:
What passed for macroeconomics on the verge of the global financial collapse had little to do with reality. The world modeled by mainstream economics bore no relation to our economy. It was based on rational expectations in which everyone bets right, at least within a random error, and maximizes anything and everything while living in a world without financial institutions. There are no bubbles, no speculation, no crashes, and no crises in these models. And everyone always pays all debts due on time.
In short, expecting the queen’s economists to foresee the crisis would be like putting flat-earthers in charge of navigation for NASA and expecting them to accurately predict points of reentry and landing of the space shuttle. The same can be said of the U.S. president’s Council of Economic Advisers (CEA)—who actually had served as little more than cheerleaders for the theory that so ill-served policy makers.
- Minsky: Stability is De-Stabilizing!
According to Minsky, the degree that the economy achieves what looks to be robust and stable growth, this is setting up the conditions in which a crash becomes ever more likely. It is the stability that changes behaviors, policy making, and business opportunities so that the instability results. Examining the history of financial crises furnishes empirical evidence for this thesis: Crashes are often preceded by long period of stability.
The Great Depression: Back in 1929, the most famous American economist, Irving Fisher, announced that the stock market had achieved a “permanent plateau,” having banished the possibility of a market crash. In the late 1960s, Keynesian economists such as Paul Samuelson announced that policy makers had learned how to “fine-tune” the economy so that neither inﬂation nor recession would ever again rear their ugly heads. In the mid-1990s, Chairman Greenspan argued that the “new economy” reﬂected in the NASDAQ equities boom had created conditions conducive to high growth without inﬂation. In 2004, Chairman Bernanke announced that the era of “the Great Moderation” had arrived so that recessions would be mild and financial ﬂuctuations attenuated.
In every case, there was ample evidence to support the belief that the economy and financial markets were more stable, that the “good times” would continue indefinitely, and that economists had finally gotten it right. In every case, the prognostications were completely wrong. In every case, the “stability is destabilizing” view had it right. In every case, Minsky was vindicated.
Minsky not only saw it coming, but all along the way he warned that “it” (another Great Depression) could happen again. In retrospect, he had identified in “real time” those financial innovations that would eventually create the conditions that led to the GFC—such as securitization, rising debt ratios, layering debts on debts, and leveraged buyouts
- Financial Crisis Inquiry Report
The crisis was foreseeable and avoidable. It did not “just happen,” and it had nothing to do with “black swans with fat tails.” It was created by the biggest banks under the noses of our regulators. This contrasts with what economists at LSE told the Queen – that these things just happen and no one can foresee them – like earthquakes.
According to the report, the GFC represents a dramatic failure of corporate governance and risk management, in large part a result of an unwarranted and unwise focus on trading (actually, gambling) and rapid growth (a good indication of fraud, as William Black argues). Indeed, the biggest banks were aided and abetted by government overseers who not only refused to do their jobs but also continually pushed for deregulation and de-supervision in favor of self-regulation and self-supervision
- Dynamite Prize: Friedman, Greenspan, Summers
Instead of helping, economists (armed with defective economic theories), actually pushed for OPPOSITE policies to those required for stabilization. President Clinton’s Secretary of the Treasury Larry Summers—a nephew of Paul Samuelson and the most prominent Harvard Keynesian of today—famously pushed for deregulation of “derivatives” that played a critical enabling role in creating the financial tsunami that sank the economy. One of the key contributions of Minsky lies in identifying the sources which make the economic system prone to crises. This diagnosis permits the design of appropriate remedies.
- Response to GFC 2007 different from response to GD 1929
Monetary and Fiscal Stimulus: Both crises were created by similar kinds of irresponsible behavior by unregulated financial institutions. However, the response to both was dramatically different. A $29 Trillion package was used to bail-out bankrupt financial institutions, and a $1 Trillion government deficit was incurred to pursue expansionary fiscal and monetary policy. This change in response also led to a change in outcomes. Financial collapse of the system was avoided. Although huge numbers became homeless and hungry, the social security programs enacted in the New Deal prevented the worst scenarios of deep massive social misery which followed the Great Depression. HOWEVER, a terrible Recession did follow, where unemployment reached double digit figures, around 25 million.
Recovery? It is claimed that there has been a recovery. Although official unemployment rates came down, much of the improvement is illusory—millions of workers have given up all hope and left the labor force. Even after years of “recovery,” both the homeownership rate (percentage of Americans who own their homes) and the employment rate (percentage of the adult population with jobs) are stuck well below where they were before the GFC. Inequality has actually increased, and all of the gains in the recovery have gone to the very top of the income and wealth distribution.
No Post-Crisis Financial Reforms: The federal government in Washington did not follow Roosevelt’s example in undertaking a thorough reform of the financial system after GD ’29. The biggest banks are actually even bigger and more dangerous than they were on the eve of the GFC. They’ve resumed many of the same practices that created the GFC. Our public stewards are again allowing this to happen. We didn’t seem to learn much from the GFC. Not only is it true that banking practices have not changed, but is also true that mainstream economics has not changed. Examination of syllabi of universities after the GFC does not reveal any significant changes in terms addition of readings on Minsky, Keynes, and others, who offer deeper insights into the crisis. The same ARCH/GARCH models that failed miserably to assess volatility in the GFC continue to be used. The same DSGE/RBS models in use to make monetary policy continue to be used all over the world.
It seems that we have not learned much from the Global Financial Crisis!
CONTINUED in L09B: Mainstream VS Minsky — goes from 27m to end of lecture (1 hr) — explains how the mainstream misunderstands Minsky, just like they misunderstook Keynes, whose work Minsky builds upon.