The Queen of England famously asked her economic advisors why none of them had seen “it” (the global financial crisis) coming. Obviously the answer is complex, but it must include reference to the evolution of economic theory over the postwar period—from the “Age of Keynes”, through the Friedmanian era and the return of Neoclassical economics, and finally on to the New Monetary Consensus with a new anti-Keynesian version of economic fine-tuning. We cannot leave out the parallel developments in finance theory—with its efficient markets hypothesis—and the subsequent deregulation and desupervision of financial institutions.
Even if the early postwar “Keynesian” economics had little to do with J.M. Keynes at least it had some connection to the world in which we actually live. What passed for macroeconomics on the precipice of the global collapse had nothing to do with reality—it is as relevant to our economy as flat earth theory is to natural science—warranting only a small footnote in the history of thought. 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.
Of course, the advisors to Presidents Bush and Obama could do no better.
Yet, there were economists who saw it coming, economists with a different approach. Many have called this a “Minsky Crisis”, after the late economist Hyman Minsky. He did see it coming. As early as 1957. No, he was not a modern day Nostradamus. Rather, he developed a theory of the evolution of the financial system and the economy—from the robust and stable system of the early postwar period, to the fragile and unstable economy that existed by the late 1990s. And while he died in 1996, many of his followers were analysing the consumer-led boom, based on debt, and arguing that a colossal collapse was coming. Yes, it is true, our projections were continually shown to be overly pessimistic; the unsustainable debt boom was sustained longer than most of us thought. But the important point is that the transformation of the economy and the unfolding of the crash were consistent with Minsky’s analysis.
This is my first column and I know you do not want an academic lecture. But in coming columns I will make references to Minsky and his approach. I was one of the very few students who sat in Minsky’s classes, who wrote a PhD dissertation under him, and who later joined him as a colleague at the Levy Economics Institute (www.levy.org). You get to know a professor’s ideas pretty well under such conditions, and your professor’s ideas will have a tremendous influence on the way you see the world. Rightly, or wrongly, Minsky’s influence is evidenced in everything I write.
In my view, what passes for conventional economic theory is wrong and dangerous. Referring to the work of the best known economists over the past 30 years, Lord Robert Skidelsky (Keynes’s biographer) argues “Rarely in history can such powerful minds have devoted themselves to such strange ideas.” There was, however, one economist who got it right and it makes sense to now take stock of his ideas—rather than turning to the Larry Summers, the Bob Rubins, the Greg Mankiws, the Marty Feldsteins, the Ben Bernankes and the John Taylors of the world, who always had it wrong.
Here’s the deal. According to Minsky, the economy emerged from WWII with a very robust financial system—hardly any private debt (it had been wiped out in the Great Depression) and lots of safe and liquid federal government debt (due to deficit spending during WWII). Various New Deal and postwar reforms also made the economy stable: a safety net that stabilised consumption (Social Security, unemployment compensation, welfare and food stamps); strict financial regulation; minimum wage laws and support of unions; low cost mortgage loans and student loans, and so on. And memories of the Great Depression discouraged risky behaviour.
Gradually all that changed—the memories faded, financial institutions got around regulations that were replaced with self-regulation, unions lost power and government support, globalization introduced low-wage competition, and the safety net was shredded. Further, profit-seeking firms and financial institutions took on greater risks with ever more precarious financing schemes. Thus, debts built-up and fragility grew on trend over the entire postwar period. This made “it” possible again.
While most who invoke Minsky focus on the crash, he believed that the main instability is a tendency toward explosive euphoria. High aggregate demand and profits that can be associated with full employment raise expectations and encourage increasingly risky ventures based on commitments of future revenues that will not be realised. A snowball of defaults then leads to a debt deflation (debtors default on their debts, which are assets of creditors) and high unemployment unless there are “circuit breakers” that intervene to stop the market forces. The main circuit breakers, according to Minsky are the Big Bank (central bank as lender of last resort) and Big Government (countercyclical budget deficits) interventions.
And, boy-oh-boy have we got a Big Bank and a Big Government! Together, the Benny and Timmy tag team have spent, lent, or guaranteed nearly $25 trillion in the name of Uncle Sam. And that still is not enough. “It” is still happening. How much more will Uncle Sam need to spend? How much more can Uncle Sam afford to spend? Is Obama taking us to the land of Weimar and Zimbabwe?
Is there an alternative—a Minskian alternative—to the policies that are failing us?
So, apologies for the lecture. Next time, we’ll channel Minsky to address such real world issues.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday.
He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).