On Monday, I was on Leonard Lopate’s WNYC radio show
talking about my recent article on John Maynard Keynes.
(The piece is no longer behind a firewall. You can read it here, and listen to the
interview here.) At the end of the show, Leonard
asked me an interesting question: Has the financial crisis
and Great Recession produced any big new economic ideas?
My immediate response was that it hasn’t, or, if it has, I
wasn’t aware of them. After the show, I thought about the
question a bit more.
I still think the answer is no. There is nothing to
compare with Keynesianism or Monetarism or even the
so-called Washington Consensus of the nineteen-eighties
and nineteen-nineties. Certainly, there is no new
Keynes. But I do think that some important ideas have
been discovered—or, rather, rediscovered. Here are six
of them, together with some tips for further reading,
one of which is rather self-serving:
1. Finance matters.
This lesson might seem obvious to the man in the street,
but many economists somehow managed to forget it. Two
who didn’t were Hyman Minsky and Wynne Godley, both of
who were associated with the Levy Institute for
Economics at Bard College. Minksy’s now-famous
“Financial Instability Hypothesis” can be found here, and one of Godley’s
warnings about excessive household debt can be found here. (It is from 1999!)
2. Credit busts are
different from ordinary recessions. On this, the
most widely quoted work is Carmen Reinhart and Ken
Rogoff’s historical survey, “This Time is Different: Eight Centuries of
Financial Folly,” which details how debt overhang
in the public and private sectors tends to produce “lost
decades.” For an old but still very readable account of
how debt overhang can create deep recessions, I would
recommend Irving Fisher’s famous essay from 1933.
For something more recent, I recommend this essay by Ray Dalio, the head of
Bridgewater Associates, the world’s biggest hedge fund.
3. Positive feedback and multiple equilibria have
to be taken seriously. With the rise of rational
expectations theory, the idea that financial markets and
entire economies can spiral into bad outcomes—and for no
very good reason—was relegated to a mathematical
curiosity: so called “sunspots.” Now, the notion is
back, and for good reason. It appears to describe the
world pretty well.
The role positive feedback played in amplifying the
credit crisis of 2008 has been studied extensively, and
this article by Princeton’s Markus
Brunnermeier provides a good survey. Turning to
what is happening in Europe, Paul
De Grauwe, of the Brussels-based Center for
European Policy Studies, and Paul Krugman have both written
interesting analyses of the Euro system from a multiple
equilibrium perspective.
4. Especially in
financial markets, self-regarding rational behavior
isn’t necessarily socially optimal. I wrote a lot
about this in my book, “How Markets Fail: The Logic of Economic
Calamities.” For those seeking a more technical
analysis, I would recommend “Risk and Liquidity,” by Princeton’s
Hyun Song Shin.
5. Monetary policy doesn’t always work very well.
This lesson should have been relearned in Japan. One
person who did relearn it was Paul Krugman. This essay of his from
1998 explains how economies can get stuck in a
“liquidity trap,” and is still worth reading, as his
book “The Return of Depression Economics,”
an updated version of which was reissued in 2008.
6. Fiscal stimulus programs don’t provide a panacea
for deep recessions, but the alternatives—do-nothing
policies or austerity—are much worse. If you doubt
this, I would suggest you look at what is happening in
Greece and the United Kingdom, where austerity programs
have been in effect for more than a year. As for the
Obama stimulus, most serious studies show it did have a
positive impact on G.D.P. growth and job creation—as
detailed in this helpful post by Dylan Matthews on
the Washington Post’s Wonkblog.
Looking at this list, anyone familiar with Keynes will
quickly realize that almost all of the points on it can
be found in his writings, at least in embryo form. If
economics is about building internally consistent models
of toy economies from first principles, he wasn’t a
great economist. If it is about providing telling
insights into how real economies function and
malfunction, he still has few rivals. That is why he
never goes away.
Endnote: Others will have different ideas about
the lessons learned in the past few years. I’d be
interested in seeing them. But please, spare yourself
the effort of posting a comment to say that Keynesian
stimulus programs don’t work or that a return to the
Gold Standard is our only salvation. Those are old
canards, not new insights.
