My Life, Economics, and Finance

There was a nice opinion by Niall Ferguson (Harvard) in the Financial Times. It’s partly on the fiscal policy, partly on the crisis and a lot on Ferguson’s dispute with Krugman (Princeton). You did not have to follow the debate (I didn’t) to understand the article, so enjoy…

The crisis is in the economic theory seen as a chance to “clean” the economy. The malinvestnment is wiped out, only fit firms survive, boom follows, and everyone lives happily ever after (or till the next crisis hits). This crisis is different. This crisis is not only affecting the economy, but also the economic theory itself.

Let’s start with the easier stuff. There is a good article by Gregory Clark. Dismal scientists: how the crash is reshaping economics

I myself was so confident of the consensus of the end of the business cycle that I persuaded by wife after the collapse of Lehman Brothers to invest all her retirement savings in the stock market, confident that the Fed would soon make things right and we could profit from the panic of a gullible public. The line “Where is my money, idiot?” is her’s.

Don’t think needs any comment.

The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.

I don’t think he is right on this one, surely not on the first part. Show me an Econ 1 course where bank bailouts are discussed. In general I would say there is a consensus that bailing out a private company is wrong, or at least the way it was done. The debate “to bail out or not to bail out” is a political one. Nothing has CHANGEd about politicians. Moreover show me an undergrad that can intelligently answer any single one of the questions posed.
I actually thing, that unlike during the Great Depression times, now there is a consensus (with the exception of few lunatics at the Mises Institute) that rates need to be cut, and spending increased (both temporarily). That is already something.
Just a side note on monetary policy. I went to a lecture by L. Smaghi (Member of Executive board of the ECB) last month where he gave an overview of unconventional monetary policy (all that he talked about ECB implemented few weeks afterwards). Actually we’ve gone a long way just from cutting the interest rates.
To conclude, if the debate seemed too simple it was because it was a political rather than an economical debate. Trust me, your 1st year BA student, even if he had an A++ in an Econ 1 class, would be lost during the lecture on unconventional monetary policy.

Then there is a great article by DeLong Progress in Macroeconomics? He is summarizing arguments for and against the idea that macroeconomics did make a progress. Blanchard is the optimist whereas Krugman, Clark, Akerlof, Shiller, Quiggin, and DeLong are the pessimists.
Akerlof, Schiller :

The economics of the textbooks seeks to minimize as much as possible departures from pure economic motivation and from rationality…. [E]ach of us has spent a good portion of his life writing in this tradition. The [self-interest and rational foresight-based] economics of Adam Smith is well understood. Explanations in terms of small deviations from Smith’s ideal system are thus clear because they are posed within a framework that is already very well understood. But that does not mean that these small deviations from Smith’s system describe how the economy actually works…. In our view, economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations [from competitive markets, self-interested motivation, and rational foresight] that actually do occur…

I am sure a lot of the “after crisis” research is going to be unconventional from today’s point of view. That is in the direction Akerlof and Schiller suggest. So if you are in the right age and considering a PhD in Econ I think the period shortly after the crisis will be a great time. “The old theory has flaws let’s come up with something new…” Your thesis supervisor is more likely listen to your ideas about “rewriting economics”.

Then there is an older article by Paul Krugman: A Dark Age of macroeconomics (wonkish) .
I think his analysis is right. The conclusion (or maybe explanation rather than conclusion) is a bit hysterical. He is saying (as the title “hints”) that we are living in a dark age of macroeconomics.

The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

I wouldn’t say that we are living in a dark age of macroeconomics, just because two guys argued (with bad arguments) against fiscal expansion. The “old” knowledge might be partially forgotten, but unlike in the dark ages books (and people – macroeconomists with different opinions) are not being burned. I think Krugman is obsessed with fiscal policy in a same way that Fama and Cochrane are obsessed with minimal government (small government is great, but not in the time of crisis). Obsession is dangerous, especially in the crisis times. There was a good article on vox by Keiichiro Kobayashi criticizing the “fiscal policy obsession” Fiscal policy again? A rebuttal to Mr Krugman.

Finally there is Eichengren’s piece. The Last Temptation of Risk.

One interpretation, understandably popular given our current plight, is that the basic economic theory informing the actions of central bankers and regulators was fatally flawed. The only course left is to throw it out and start over. But another view, considerably closer to the truth, is that the problem lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking.

the belief that risk and return could be reduced to a set of equations specified by an MBA and solved by a machine.

I like Eichengreen’s article. I think it’s well balanced and he is not overly critical of the profession (Very critical of MBA’s though )

…The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object…

So it’s not a dark age after all.