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.
