Posts filed under ‘Bailout / Financial Crisis’
| Peter Klein |
We’ve previously discussed attempts to blame the accounting scandals of the early 2000s on the teaching of transaction cost economics and agency theory. By describing the hazards of opportunistic behavior and shirking, professors were allegedly encouraging students to be opportunistic and to shirk. Then we were told that business schools teach “a particular brand of free-market ideology” — the view that “the market always ‘gets prices right’ and “[a]n individual’s worth can be reduced to one’s worth in the market” — and that this ideology was partly responsible for the financial crisis. (My initial reaction: Where to I sign up for these courses?!)
The Guardian reports now on a movement in the UK to address “the crisis in economics teaching, which critics say has remained largely unchanged since the 2008 financial crash despite the failure of many in the profession to spot the looming credit crunch and worst recession for 100 years.” If you think this refers to a movement to discredit orthodox Keynesianism, which dominates monetary theory and practice in all countries, and its view that discretionary fiscal and (especially) monetary policy are needed to steer the economy on a smooth course, with particular attention to asset markets where prices must be rising at all times, you’d be wrong. No, the reformers are calling for “economics courses to embrace the teachings of Marx and Keynes to undermine the dominance of neoclassical free-market theories.” To their credit, the reformers appear also to want more attention to economic history and the history of economic thought, which is all to the good. But the reformers’ basic premise seems to be that mainstream economics is too friendly toward the free market, and that this has left students unprepared to understand the “post-2008″ world.
To a non-Keyensian and non-Marixian like me, these arguments seem to come from a bizarro world where the sky is green, water runs uphill, and Janet Yellen is seven feet tall. It’s true that most economists reject economy-wide central planning, but the vast majority endorse some version of Keynesian economic policy complete with activist fiscal and monetary interventions, substantial regulation of markets (especially financial markets), fiat money under the control of a central bank, social policy to encourage home ownership, and all the rest. We’ve pointed many times on this blog to research on the social and political views of economists, who lean “left” by a ratio of about 2.5 to 1 — yes, nothing like the sociologists’ zillion to 1, but hardly evidence for a rigid, free-market orthodoxy. I note that the reformers described in the Guardian piece never, ever offer any kind of empirical evidence on the views of economists, the content of economics courses, or the influence of economics courses on economic policy. They simply assert that they don’t like this or that economic theory or pedagogy, which somehow contributed to this or that economic problem. They seem blissfully unaware of the possibility that their own policy preferences might actually be favored in the textbooks and classrooms, and might have just a teeny bit to do with bad economic policies.
I’m reminded of Sheldon Richman’s pithy summary: “No matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom that remains.”
| Peter Klein |
Central to the “Austrian” understanding of business cycles is the idea that monetary expansion — in Wicksellian terms, money printing that pushes interest rates below their “natural” levels — leads to overinvestment in long-term, capital-intensive projects and long-lived, durable assets (and underinvestment in other types of projects, hence the more general term “malinvestment”). As one example, Austrians interpret asset price bubbles — such as the US housing price bubble of the 1990s and 2000s, the tech bubble of the 1990s, the farmland bubble that may now be going on — as the result, at least partly, of loose monetary policy coming from the central bank. In contrast, some financial economists, such as Laureate Fama, deny that bubbles exist (or can even be defined), while others, such as Laureate Shiller, see bubbles as endemic but unrelated to government policy, resulting simply from irrationality on the part of market participants.
Michael Bordo and John Landon-Lane have released two new working papers on monetary policy and asset price bubbles, “Does Expansionary Monetary Policy Cause Asset Price Booms; Some Historical and Empirical Evidence,” and “What Explains House Price Booms?: History and Empirical Evidence.” (Both are gated by NBER, unfortunately, but there may be ungated copies floating around.) These are technical, time-series econometrics papers, but in both cases, the conclusions are straightforward: easy money is a main cause of asset price bubbles. Other factors are also important, particularly regarding the recent US housing bubble (I suspect that housing regulation shows up in their residual terms), but the link between monetary policy and bubbles is very clear. To be sure, Bordo and Landon-Lane don’t define easy money in exactly the Austrian-Wicksellian way, which references natural rates (the rates that reflect the time preferences of borrowers and savers), but as interest rates below (or money growth rates above) the targets set by policymakers. Still, the general recognition that bubbles are not random, or endogenous to financial markets, but connected to specific government policies designed to stimulate the economy, is a very important result that will hopefully influence current economic policy debates.
| Peter Klein |
I’ve argued before (1, 2) that the usual arguments for central bank independence aren’t very strong, particularly in the current environment where Bernanke has interpreted the “unusual and exigent circumstances” provision to mean “I will do whatever I want.” (This was a major point in my Congressional testimony about the Fed.) So it was nice to see Olivier Blanchard express similar reservations in an interview published in today’s WSJ (I assume it’s not an April Fool’s Day prank):
One of the major achievements of the last 20 years is that most central banks have become independent of elected governments. Independence was given because the mandate and the tools were very clear. The mandate was primarily inflation, which can be observed over time. The tool was some short-term interest rate that could be used by the central bank to try to achieve the inflation target. In this case, you can give some independence to the institution in charge of this because the objective is perfectly well defined, and everybody can basically observe how well the central bank does..
If you think now of central banks as having a much larger set of responsibilities and a much larger set of tools, then the issue of central bank independence becomes much more difficult. Do you actually want to give the central bank the independence to choose loan-to-value ratios without any supervision from the political process. Isn’t this going to lead to a democratic deficit in a way in which the central bank becomes too powerful? I’m sure there are ways out. Perhaps there could be independence with respect to some dimensions of monetary policy - the traditional ones — and some supervision for the rest or some interaction with a political process.
| Dick Langlois |
Rebecca Henderson, one of my favorite management scholars, has a new paper (with Karthik Ramanna) on – Milton Friedman and business ethics. Here’s the abstract.
Managers and Market Capitalism
In a capitalist system based on free markets, do managers have responsibilities to the system itself, and, in particular, should these responsibilities shape their behavior when they are attempting to structure those institutions of capitalism that are determined through a political process? A prevailing view — perhaps most eloquently argued by Milton Friedman — is that managers should act to maximize shareholder value, and thus that they should take every opportunity (within the bounds of the law) to structure market institutions so as to increase profitability. We maintain here that if the political process is sufficiently ‘thick,’ in that diverse views are well-represented and if politicians and regulators cannot be easily captured, then this shareholder-return view of political engagement is unlikely to reduce social welfare in the aggregate and thus damage the legitimacy of market capitalism. However, we contend that sometimes the political process of determining institutions of capitalism is ‘thin,’ in that managers find themselves with specialized technical knowledge unavailable to outsiders and with little political opposition — such as in the case of determining certain corporate accounting standards that define corporate profitability. In these circumstances, we argue that managers have a responsibility to structure market institutions so as to preserve the legitimacy of market capitalism, even if doing so is at the expense of corporate profits. We make this argument on grounds that it is both in managers’ self-interest and, expanding on Friedman, managers’ ethical duty. We provide a framework for future research to explore and develop these arguments.
On the one hand, we might quibble about whether they get Friedman right. Friedman meant in the first instance that managers should pursue their self-interest within the framework of “good” institutions, not in the (Public Choice) context of changing the institutional framework itself. I haven’t actually gone back to see what Friedman says about this, but here is how Henderson and Ramanna interpret the Chicago tradition: “Friedman and his colleagues were keenly aware that capitalism can only fulfill its normative promise when markets are free and unconstrained, and that managers (and others) have strong incentives to violate the conditions that support such markets (e.g., Stigler, 1971). But they argued both that dynamic markets tend to be self-healing in that the dynamics of competition itself generates the institutions and actions that maintain competition and that government could be relied on to maintain those institutions—such as the legal system—that are more effectively provided by the state (on this latter point, see, in particular, Hayek, 1951).” There is a sense in which Chicago saw (and economic liberals in general see) the system as self-healing in the longest of runs: every inefficiency is ultimately a profit opportunity for someone who can transmute deadweight loss into producer’s surplus; and economic growth cures a lot of ills. But one can hardly accuse Chicago of being insensitive to those bad incentives for rent-seeking in the short and medium term.
On the other hand, Henderson and Ramanna make a valuable point when they draw our attention to the gray area in which market-supporting institutions (the same term I tend to use) are often forged through private action or through public action in which the private actors possess the necessary local knowledge. There is a scattered literature on this – the setting of technical standards, for example – but it is not a major focus of Public Choice or political economy. Perhaps it is naïve to say that managers in this gray area have an ethical duty to support institutions that make the pie bigger rather than institutions that transfer income to them. But what else can we say? It’s a lot better than blathering on about “public-private partnerships,” which are frequently cover for rent-seeking behavior. One (possibly embarrassing) implication of this stance is that it makes a hero of the much-reviled Charles Koch, who funds opposition to many of the rent-seeking institutions from which his own company benefits.
At one point Henderson and Ramanna mention the Great Depression as a “market failure” that incubated anti-capitalist sentiment. The second part of that assertion is certainly true, but the Depression was not a market failure but a spectacular failure of government. (Read Friedman (!), whose once-controversial view about this is now widely accepted by economic historians and monetary economists, including Ben Bernanke.) The Depression is actually an interesting case study in the gray area of institutions. Before the Fed, private financiers acted collectively to provide the public good of stopping bank panics. Now that role has fallen to the state, with private interests – and their asymmetrical local knowledge – influencing the bailout process. Which system was less corrupt? A more general question: are there any examples of fully private creation of institutions in which the self-interest of the participants led to inefficient rent-seeking?
| Peter Klein |
Paul Krugman writes a typically silly column on the Austrian school’s approach to defining the money supply. As usual, his purpose is not to inform, or analyze, or explore, but to ridicule anyone who disagrees with The Paul. A few reactions:
- The substantive question, do Austrians consider money-market mutual funds as part of the money supply, is easily answered with 30 seconds of research, which is apparently more than Paul could muster up. Paul, use The Google!
- Krugman frequently mocks ideas he does not understand, so his tone and style here are hardly surprising. But it’s interesting that he finds Ron Paul’s “hard-money” views influential enough to mention.
- Krugman seems to believe that the Republican Establishment, and Paul Ryan in particular, are in thrall to the economic teachings of the Austrian school, which would be news to everyone in the Republican Establishment and the Austrian school. In his defense, I think Krugman recognizes only Krugman and non-Krugman, so he cannot quite grasp that there may be some diversity among his critics.
- Krugman dimly recognizes that Austrians have some objections to fractional-reserve banking in connection with government intervention, and sneers that “[t]his is historically wrong, but maybe the actual history of banking is deep enough in the past for that wrongness to get missed.” He also seem to think that Austrians want to ban the use of money-market mutual funds. Of course, Krugman has never read anything written by an Austrian economist, and he offers no citations or quotes, so it’s hard to know where he gets these ideas. To my knowledge. no Austrian has called for banning MMMFs. On fractional-reserve banking, the opinion among Austrian scholars ranges from those who think FRB is inherently unworkable and illegitimate and could not survive apart from government intervention (most Rothbardians) to those who think that private FRB is legitimate and workable but that the current system of government deposit insurance, government fiat currency as the base money, the Fed as the lender of last resort, etc. is inefficient and illegitimate (Larry White, George Selgin). Needless to say, Austrian scholars have written thousands of pages on these issues, including detailed studies of the history of banking. Krugman apparently thinks Austrians are merely journalists or propagandists, as he himself has become.
| Peter Klein |
Courtesy of David Stockman (via Dennis):
[T]he clamoring and clattering that you hear from the Keynesians . . . that austerity is bad forgets the fact that austerity isn’t an elective course. Austerity is something that happens to you when you’re broke.
| Peter Klein |
The latest issue of the Erasmus Journal for Philosophy and Economics features an interview with Gary Becker on rational choice. I am not a Chicagoite positivist, but I sympathize with Gary’s overall take on the behavioral revolution: Meh.
Interviewer: Following the crisis, many economists and methodologists have argued that more realistic behavioral underpinnings of economic theory would have made forecasts more accurate. Do you think that one of the things the recent crisis has shown us is that people just do not behave rationally? Or did the crisis rather show exactly the opposite—that people did in fact react to incentives and that the consequences of introducing new financial instruments were just not foreseeable?
Becker: I think it is mainly the latter. There were incentives, both on the borrower and on the lender side, that these subprime loans would be made available at the lowest interest rates; and there was pressure from the government to do so; and probably those involved did not understand the financial instruments. Now, is it that we have to change our theories radically with respect to their behavioral structure or even switch to a new behavioral framework? There is very little evidence that would support such a move.
A later remark supports my argument that “disequilibrium analysis” is not the defining characteristics of the Austrian school:
I have read some of the literature on the critique of equilibrium, not so much by philosophers but by the Austrian school of economics, and I could just never make sense out of it, because I do not see what they are substituting for it. Even Friedrich Hayek, who is listed as one of the top Austrians, if you read his analysis, you see that he is using equilibrium analysis.
| Peter Klein |
A very nice overview of “Austrian” capital theory and its relevance for the current economic crisis from former guest blogger Peter Lewin.
With the resurgence of Keynesian economic policy as a response to the current crisis, echoes of past debates are being heard — in particular the debate from the 1930s between John Maynard Keynes and Friedrich Hayek. . . . Hayek pointed out that capital investment does not simply add to production in a general way but rather is embodied in concrete capital items. That is, the productive capital of the economy is not simply an amorphous “stock” of generalized production power; it is an intricate structure of specific interrelated complementary components. Stimulating spending and investment, then, amounts to stimulating specific sections and components of this intricate structure.
See also the recent SO!APbox essay by Rajshree Agarwal, Jay Barney, Nicolai, and me, “Heterogeneous Resources and the Financial Crisis: Implications of Strategic Management Theory.”
| Peter Klein |
Two years ago I was in D.C. on Hayek-Klein day and found myself on an elevator with Ben Bernanke, upon which I persuaded him to sing me a few bars of Happy Birthday. True story. This year I was in D.C. again, this time to give an organizational economist’s perspective on the Federal Reserve System to the House Financial Services Committee’s Subcommittee on Domestic Monetary Policy and Technology. You can read my written testimony here and see the oral remarks at C-SPAN which has archived the event.
That’s Jeff Herbener to my right and John Taylor to my left, with Jamie Galbraith by Taylor. The one on the end is not Yoda, but Alice Rivlin.
Because the hearing was televised, I can truthfully say, “I’m not a macroeconomist, but I play one on TV.”
| Peter Klein |
What labor economists call “churn” is an important part of creative destruction, the combining and recombining of productive resources as business entities appear and disappear. New paper:
Hiring, Churn and the Business Cycle
Edward P. Lazear, James R. Spletzer
NBER Working Paper No. 17910
Issued in March 2012
Churn, defined as replacing departing workers with new ones as workers move to more productive uses, is an important feature of labor dynamics. The majority of hiring and separation reflects churn rather than hiring for expansion or separation for contraction. Using the JOLTS data, we show that churn decreased significantly during the most recent recession with almost four-fifths of the decline in hiring reflecting decreases in churn. Reductions in churn have costs because they reflect a reduction in labor movement to higher valued uses. We estimate the cost of reduced churn to be $208 billion. On an annual basis, this amounts to about .4% of GDP for a period of 3 1/2 years.
| Peter Klein |
I don’t think of Ben Bernanke’s approach to monetary policy as soft, passive, or restrained, but of course my optimal monetary policy is no monetary policy. Laurence Ball thinks that Bernanke’s actions after 2008 were surprisingly cautious, compared to what Bernanke advocated as an academic and Fed Governor in the early 2000s.
From 2000 to 2003, when Bernanke was an economics professor and then a Fed Governor (but not yet Chair), he wrote and spoke extensively about monetary policy at the zero bound. He suggested policies for Japan, where interest rates were near zero at the time, and he discussed what the Fed should do if U.S. interest rates fell near zero and further stimulus were needed. In these early writings, Bernanke advocated a number of aggressive policies, including targets for long-term interest rates, depreciation of the currency, an inflation target of 3-4%, and a money-financed fiscal expansion. Yet, since the U.S. hit the zero bound in December 2008, the Bernanke Fed has eschewed the policies that Bernanke once supported and taken more cautious actions — primarily, announcements about future federal funds rates and purchases of long-term Treasury securities (without targets for long-term interest rates).
Ball describes a June 2003 meeting of the Fed’s Open Market Committee at which senior staffer Vincent Reinhart convinced Bernanke that when interest rates are near zero, the right policies are persuading market participants that federal funds rates will continue to fall, selling medium-term bonds and buying longer-term ones (“Operation Twist”), and quantitative easing. When the financial crisis hit, this is exactly what Bernanke did, although — according to Ball — Bernanke had long argued for much more aggressive moves.
Ball argues that Bernanke fell victim to groupthink:
We can interpret the June 2003 FOMC meeting as an example of groupthink. The recommendations in Reinhart’s briefing were presented as the views of a unified Fed staff. In the FOMC discussion, nobody, including Chairman Greenspan, seriously questioned Reinhart’s focus on his three preferred policy options. By the time Bernanke spoke, a consensus had emerged on a number of points, such as opposition to targets for long-term interest rates. Groupthink may have discouraged Bernanke from shaking up the discussion with his past ideas for zero-bound policy.
A reluctance to disagree with the consensus was common at the Greenspan Fed, according to some observers. Cassidy (1996) describes how Alan Blinder, Fed Vice Chair from 1994 to 1996, reacted to FOMC meetings: “The thing that surprised Blinder most was the way decisions were made at the Board. Most of the time, the governors were presented with only one option: the staff recommendation.”
He also suggests that Bernanke, unlike Greenspan, Paulson, Summers, and other key economic policy figures, is shy, withdrawn, and unassertive.
Without intending to, I think Ball makes powerful arguments against conventional monetary policy itself, which relies on a small, secretive, cabal of powerful technocrats, interest-group representatives, and fixers to design and implement rules and procedures that affect the lives of millions, that reward some (commercial and investment bankers, homeowners) and punish others (savers, renters), that shape the course of world events. Do we really want a system in which one person’s personality type has such a huge effect on the global economy?
| Peter Klein |
You’ve all heard the story of the Manhattan socialite who expressed shock at Nixon’s landslide 1972 victory because “nobody I know voted for him.” (Attributed variously to Pauline Kael, Katharine Graham, Susan Sontag, and others, and probably apocryphal, but who cares; it’s a great quote.) I was reminded of this by a line in Larry Summers’s confidential 2008 economic policy memo now making the rounds, courtesy of the New Yorker: “Greg Mankiw is the only economist we have consulted with [about the optimal stimulus package] who refused to name a number and was generally skeptical about stimulus.” How can a huge stimulus package be wrong — everybody I know favors it!
(For the record, the economists consulted — supposedly representing the full spectrum of legitimate opinion — were Robert Reich (recommended stimulus: $1.2 trillion over 2 years), Joe Siglitz ($1 trillion over two years), Paul Krugman ($600 billion in one year), Jamie Galbraith ($900 billion in one year), Dean Baker and colleagues ($900 billion), Marty Feldstein ($400 billion in one year), Larry Lindsey ($800 billion to $1 trillion), Ken Rogoff ($1 trillion over two years), Mark Zandi ($600 billion in one year), an unnamed group of Fed officials (over $600 billion), Adam Posen ($500-700 billion in one year), and an unnamed group at Goldman Sachs(!) ($600 billion). So, we’ve got left-wing Keynesians, right-wing Keynesians, moderate Keynesians, Robert Reich who wouldn’t know a Keynesian from a Kenyan, and Goldman Sachs. How’s that for diversity of opinion?)
Update: Mankiw agrees: “Of course, the fact that I was ‘the only economist’ expressing skepticism reflects the range of economists that Team Obama chose to consult.”
Keynes’s idea that investors are motivated by “animal spirits” has come back into vogue with the recent Keynesian revival, but the term is often misunderstood. Keynes referred not to psychological factors that make investors reluctant to invest, but those that make them invest at all — in the face of deep uncertainty, he thought, only a manic, driven, strong-willed person would put capital at risk. When animal spirits are strong, investment is sufficient to maintain aggregate demand; when they lag, aggregate demand falls, and the economy lapses into depression. (Lord Skidelsky approvingly calls this the “mood swings theory” of business cycles — an idea just crazy enough to spawn a recent NBER paper.)
The new issue of Capitalism and Society features a piece on What Keynes Really Meant on this issue, and it’s a good read:
Alexander Dow, Glasgow Caledonian University
Sheila C. Dow, University of Stirling
The term ‘animal spirits’ has returned to academic and public discourse in a way which departs significantly from the original use of the term by Keynes. The new behavioural economics literature uses the term to refer to a range of behaviour which falls outside what is normally understood as rational. This treatment follows from the mainstream dichotomisation between rationality and irrationality. However, Keynes explained that, given fundamental uncertainty, rationality alone was insufficient to justify action. Animal spirits was the name he gave to the (psychological) urge to action which explained decisions being taken in spite of uncertainty; animal spirits for him were neither rational nor irrational. Nor are they beyond analysis. We explore how the nature and role of animal spirits can vary according to context (as between different sectors, types of firm and within firms). This analysis indicates ways in which policy can promote structural change to strengthen animal spirits in the long term as well as offset short-term weakening in animal spirits.
| Peter Klein |
The idea that mainstream macroeconomic thinking focuses at too high a level of aggregation is a frequent complaint on this blog (e.g., here, here, here, and here). Our recent Strategic Organization paper hammers home this point. The level of aggregation is of course a fundamental difference between Keynesian and Austrian theorizing about economic fluctuations. But Keynesian economists don’t seem to recognize this.
The other day I posted a snarky blog entry at The Beacon, responding to a Krugman smear of Hayek (yawn). Today Mario Rizzo pens a more thoughtful response, emphasizing exactly this level-of-analysis issue:
I think the real issue is this. Hayek’s approach attacks, root-and-branch, the macroeconomic way of thinking. It is not simply a challenge to a particular theory of the determinants of mass unemployment, inflation, business cycles and the like. Hayek is not accepting the rules of the game or the parameters of the sub-discipline of modern macroeconomics. Hayek does not want to argue that the government expenditure multiplier is 0.5 instead of 2.0, for example. He does not want to discuss just how much fiscal stimulus should be undertaken and what form it should assume.
In short, he does not want to focus on aggregate spending and aggregate consequences. Hayek’s approach says: Let us pierce the veil of aggregates and look at the distortive effects on relative prices and relative output produced by boom-time credit expansions. Let us look at the distortive effects that booms leave us as we work our way through a recession. Let us concentrate on sustainable lines of expenditure both during the boom and during the road out from the bust.
| Peter Klein |
When the subject is large financial or industrial companies, the answer is clearly no. Government promises not to rescue failing banks or large firms are cheap talk, not credible commitments. A central government strong enough to bail out politically connected organizations will bail them out; the only government that can credibly commit not to intervene is one that is not legally empowered to intervene. And no modern state is willing to give up that discretionary authority. Here is evidence from Korea:
Ending “Too Big To Fail”: Government Promises vs. Investor Perceptions
Todd A. Gormley, Simon Johnson, Changyong Rhee
NBER Working Paper No. 17518, October 2011
Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea’s 1997-99 crisis, suggests an answer: No. Despite a general “no bailout” policy during the crisis, the largest Korean corporate groups (chaebol) – facing severe financial and governance problems – could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests “too big to fail” beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.
| Peter Klein |
A nice post from former guest blogger Craig Pirrong on regime uncertainty and its role in hampering economic recovery. As Craig points out, it’s not the level of government intervention per se that delays investment, but uncertainty about anticipated changes in government intervention. Options theory provides a useful way to see this.
| Lasse Lien |
Good papers often seem like they are long overdue. One can’t help but wonder why they weren’t written a long time ago since the questions they raise are of such obvious interest and importance. In that sense I think this paper qualifies as overdue:
Abstract: How economic crises impact the boundaries of firms has been offered virtually no attention in the literature on the theory of the firm. I review the best-known theories of the firm and identify the variables that matter for the explanation of firm boundaries. I then examine how an economic crisis may impact these variables and change efficient firm boundaries. The various theories of the firm have difficulties explaining how firms efficiently adapt their boundaries to such prominent characteristics of economic crisis as declining demand and increased costs of external finance. However, all these theories stress uncertainty as an antecedent of firm organization, and as uncertainty is also an important characteristic of an economic crisis I examine how uncertainty is allowed to play out in the various theories in order to identify what predictions we can derive from the theory regarding changes in efficient firm boundaries as consequence of changes in uncertainty. The analysis suggests that we need to be more precise in describing the nature of the uncertainty that is assumed in the various theories. Moreover, allowing for changes in levels of uncertainty requires that we take the processes of boundary changes into account in the theory of firm boundaries.
Foss, Kirsten. 2010. How do economic crises impact firm boundaries? European Management Review7: 217–27.
| Nicolai Foss |
We have often blogged on the work of Axel Leijonhufvud on O&M (here). Here is a 2008 talk which was given in Denmark (and which, unfortunately, somehow missed my attention at that time) on “Keynes and the Crisis.” The talk contains many characteristic Leijonhufvudian themes (smashing of Ricardian equivalence, representative agent modeling, and the foundations of financial theory), little on Keynes (luckily!), and much critique of monetarism, in particular the choice of the CPI as the unique target of central bank policies and the notion of the independence of central banks from the political system. Here is Leijonhufvud’s overall diagnosis of the root causes of the current crisis:
The process leading up to today’s American financial crisis had the dollar exchange rate supported by foreign central banks exporting capital to the United States. This capital inflow was not even to be discouraged by a Federal Reserve policy of extremely low interest rates. The price elasticity of exports from the countries that prevented the appreciation of their own currencies in this way kept US consumer goods prices from rising. Operating an interest-targeting regime keying on the CPI, the Fed was lured into keeping rates far too low far too long. The result was inflation of asset prices combined with a general deterioration of credit quality (Leijonhufvud 2007a). This, of course, does not make a Keynesian story. It is rather a variation on the Austrian overinvestment theme.
| Peter Klein |
An important point from Ken Rogoff:
Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.
For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries. For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.
I don’t agree with all of the discussion, for example Rogoff’s call for price inflation to mitigate the burden on debtors, but this is a big advance over the vulgar Keynesianism that passes for analysis at the New York Times. (See also Peter L.’s post on Rumelt.) The main point is that a recession like the present one is structural, and has nothing do with shibboleths like “insufficient aggregate demand.” I wish Rogoff (here or in his important book with Carmen Reinhart) talked about credit expansion as the source of structural, sectoral imbalances that generate macroeconomic crises.
| Peter Klein |
Frivolous commentary on the US debt crisis (like this) attributes to opponents of raising the debt ceiling the view that “defaults don’t matter.” Sensible people recognize, of course, that default (and even repudiation) are policy options that have benefits and costs, just as continuing to borrow and increasing the debt have benefits and costs. Reasonable people can disagree about the relevant magnitudes, but comparative institutional analysis is obviously the way to go here. (Unfortunately, most of the academic discussion has focused entirely on the possible short-term costs of default, with almost no attention paid to the almost certain long-term costs of continued borrowing.)
I’m a bit surprised no one has brought up William English’s 1996 AER paper, “Understanding the Costs of Sovereign Default: American State Debts in the 1840′s,” which provides very interesting evidence on US state defaults. It’s not a natural experiment, exactly, but does a nice job exploring the variety of default and repudiation practices among states that were otherwise pretty similar. Here’s the meat:
Between 1841 and 1843 eight states and one territory defaulted on their obligations, and by the end of the decade four states and one territory had repudiated all or part of their debts. These debts are properly seen as sovereign debts both because the United States Constitution precludes suits against states to enforce the payment of debts, and because most of the state debts were held by residents of other states and other countries (primarily Britain). . . .
In spite of the inability of the foreign creditors to impose direct sanctions, most U.S. states repaid their debts. It appears that states repaid in order to maintain their access to international capital markets, much like in reputational models. The states that repaid were able to borrow more in the years leading up to the Civil War. while those that did not repav were, for the most part, unable to do so. States that defaulted temporarily were able to regain access to the credit market by settling their old debts. More surprisingly, two states that repudiated a part of their debt were able to regain access to capital markets after servicing the remainder of their debt for a time.
Amazingly, the earth did not crash into the sun, nor did the citizens of the delinquent states experience locusts, boils, or Nancy Grace. Bond yields of course rose in the repudiating, defaulting, and partially defaulting states, but not to “catastrophic” levels. There were complex restructuring deals and other transactions to try to mitigate harms.
A recent CNBC story on Europe cited “the realization that sovereign risk, and particularly developed market sovereign risk exists, because most developed world sovereign was basically treated as entirely risk free,” quoting a principal at BlackRock Investment Institute. “With hindsight, we can say . . . that they have never been risk free, it’s just that we have been living in a quiet time over the last 20 years.” Doesn’t sound like Apocalypse to me.