Bookblogging: Failure of the Great Moderation

by John Quiggin on August 24, 2009

Another section of the Great Moderation chapter from my book. I’m getting a lot of value from the comments, both favorable and critical, so please keep them coming.


Failure


Whether it was a real economic phenomenon or a statistical illusion, the Great Moderation, considered as a pattern of long expansions punctuated by brief and mild recessions, is clearly over. In retrospect, it was over by the time its discovery was announced in the early 2000s. The recovery from the 2001 recession was not, as advocates of the Great Moderation supposed, the beginning of a third long expansion in the United States. Rather, it was weak, short-lived and overwhelmingly driven by the unsustainable bubble in housing prices and the expansionary monetary policies of Greenspan and Bernanke. The expansion lasted only six years, and it was four years old before total employment regained the pre-recession peak. All of the employment gains of the expansion, and more, were wiped out in the first few months of the global financial crisis.


The US experience was fairly typical of the developed countries. While some, such as Australia and Canada did rather better, others such as Ireland and Iceland suffered economic meltdowns with output losses in excess of 10 per cent.


But it is not sufficient to point out the obvious fact that the Great Moderation is finished. The thinking that made so many economists willing to endorse claims that the business cycle had been tamed by financial liberalisation remains influential and is implicit in many arguments about policy responses to the Crisis. So it is important to understand why the Great Moderation hypothesis was so badly wrong.


#


The dissenters




While the boom persisted, the view that the Great Moderation was the product of unsustainable policies received little attention. It was espoused only by old-style Keynesians, a relatively marginal group on the left of the economics profession, and members of the Austrian School, a fringe group on the right. While the two groups agreed in offering a negative prognosis, they differed radically regarding both diagnosis and proposed cure.


Keynesians argued that, without adequate regulation, financial instability was inevitable. This view was part of the assumed background for Keynesians of all kinds, but it was particularly stressed by the post-Keynesian school associated with the late Hyman Minsky.


Minsky focused on the instability of credit and investment processes in a market economy and argued that capitalist financial systems are inherently unstable because large swings in investor expectations tend to occur over the course of the economic cycle. He argued that in a recession, expectations are subdued. As the recovery gathers pace, profits rise and balance sheets are restored. Caution remains for a period, reflecting memories of the previous downturn. As the economy continues to grow, perhaps spurred further by technological breakthroughs or unexpectedly high rates of growth, profits are rebuilt and expectations of future growth begin to rise. Caution begins to recede. Increasingly, animal spirits are stirred and banks begin lending more freely and credit expands. Even cautious investors are encouraged to join the upward surge for fear of forfeiting profit opportunities. Momentum builds behind what Minsky referred to as the “euphoric economy.” This attracts highly leveraged asset speculators—Minsky called them “Ponzi financiers”—who rely on rising asset prices to service debt and who drive the market further upward. Increasingly, the market is dominated by speculation about sentiments and movements in the market rather than about fundamental asset values.


Minsky’s work became a standard namecheck for Keynesians writing about financial crises past, present and future. For example, Charles Kindleberger used Minsky’s model as the basis for his study Manias, Panics, and Crashes, declaring that “the model lends itself effectively to the interpretation of economic and financial history. In my own work with political scientist Stephen Bell, I noted that the main obstacle to broader acceptance of Minsky’s work was the lack of a formal derivation from microeconomic foundations (see Ch …) and concluded that ‘Another significant cycle of asset price movements, especially in one of the major economies, could see a fundamental revision of thinking about the costs and benefits of liberalized financial systems.’


While Keynesians argued that instability is inherent in weakly regulated financial systems, economists of the Austrian school generally claimed that the business cycle was the product of government intervention, and particularly of central banking. This view was derived from the work of Friedrich von Hayek and Ludwig von Mises, economists who were literally Austrians by birth. But if the Austrians agree on the evils of central banking, they disagree on almost everything else. Some, endorsing the judgement of the mainstream economists who awarded Hayek the Nobel prize in economics, see him as having far surpassed the initial contributions of his teacher von Mises. Others see von Mises as the true source, and his American student Murray Rothbard as his intellectual heir.


The disagreements don’t stop there. Some Austrians, despite generally rejecting government, favor a government-enforced gold standard and the prohibition of fractional reserve banking (the system by which banks lend out most of the money deposited with them, retaining only a fraction to meet the needs of depositors who wish to withdraw their funds). Others advocate ‘free banking’ with no government role of any kind, a position which is perhaps more intellectually consistent, but somewhat undermined by the observation that free banking systems have been tried and failed (the 1890s boom and bust in Australia is a particularly clear-cut example.


Whatever their disagreements and theoretical limitations, Keynesians and Austrians mostly got it right as regards the bubble economy of the decade leading up to the crisis. This is not to say that they predicted the timing and course of the crisis in detail. It is in the nature of bubbles that their bursting is unpredictable and has unpredictable consequences. Even the most accurate prophets, such as Nouriel Roubini of the Stern School of Business focused more on international imbalances and unsustainable housing prices rather than on the largely opaque superstructure of financial transactions that financed and magnified these imbalances.


#


Was there really a Great Moderation?


The abrupt end to the Great Moderation raises anew the question of whether it was a real phenomenon or an over-optimistic interpretation of the data. Even when the Great Moderation was generally accepted, it was not the only interpretation put forward. In a paper published by the Brookings Institute in 2001 Olivier Blanchard of MIT and John Simon of the Reserve Bank of Australia argued that the data implied a long-term decline in volatility since the 1950s, interrupted temporarily in the 1970s and early 1980s.


Although this interpretation fitted the data as well as the standard view, it was not widely accepted.The reason is obvious enough. A statistical test suggesting that the economy was much more volatile in the 1950s and 1960s than in the 1990s is hard to accept in view of the actual experience of the postwar boom as a period of strong growth and low unemployment. If measures of volatility contradict this experience, the obvious response is to suggest that they must not be measuring the right thing.


But if data on quarterly volatilty can so easily be used to derive results that are so obviously problematic, this must cast doubt on their use to support the standard Great Moderation story. It is therefore worth looking more closely at the measures and their interpretation.


The first difficulty with a focus on the volatility of output growth is that it takes no account of changes in the average rate of economic growth. Looking at US growth rates, for example, the standard deviation of the rate of economic growth was 2.0 per cent in the 1960s, as compared to 1.5 percentage points in the 1990s. This seems to support the usual story suggesting a decline in volatility


But the average rate of output growth was 4.3 per cent in the 1960s, and only 3.0 per cent in the 1990s. So, expressed relative to the average growth rate, volatility was actually lower in the 1960s.


A second problem is that quarterly volatility measures are sensitive to relatively short-term fluctuations (in the statistical jargon, this is called high-frequency volatility). The same is true of the NBER measure which defines a recession as a downturn lasting a few quarters. These measures have their advantages, but they miss some critical features of the cycle.


Although the post war boom was characterised by relatively frequent recessions these recessions were not felt as being particularly severe because they were typically followed by rapid and strong recoveries – they had to be, given the high average rate of economic growth.


The recoveries following the recessions of 1990-91 and 2001 were different, so different that the term ‘jobless recovery’ was coined to describe them. Well after output had begun to recover, employment kept falling and unemployment kept rising. In each case the recovery in output was sufficient to constitute a recovery according to the popular ‘negative growth’ definition, and also according to the somewhat broader criteria used by the NBER. But to the average person, the early years of these expansions felt much like recessions.


President George HW Bush was among the first casualties of the new-style business cycle. By the time of the 1992 US election, the economy was about 18 months into an expansion, according to the standard measures. But Bill Clinton, campaigning on the slogan ‘It’s the economy, stupid’ was able to capitalise on the actual experience which was that of continuing depressed conditions.


The same experience was repeated after the 2000 recession.


The jobless recovery phenomenon was not confined to the US. In Australia, for example, the economy went into recession in 1989 and, on the standard measures, began a renewed expansion in 1990. But unemployment peaked at … in … and did not regain its 1989 levels until … , … years into one of the longest expansions on record.


As in the US, … The Labor government that had presided over the recession managed to scrape back into office in 1993. By 1996, with an expansion more than five years old, and unemployment rates finally declining, Labor hoped to be rewarded for the recovery. But the opposition parties judged the public mood more accurately, arguing that ‘five minutes of economic sunshine’ was no reward for what was popularly perceived as a multi-year recession.


But if the standard measures of quarterly volatility did not match the experience of workers in general, they fitted very neatly with that of participants in financial markets. For these groups the recessions were periods of severe les






#


Individual and aggregate volatility


Economic analysis of the Great Moderation showed a striking paradox. Even though economic aggregates appeared to be more stable than at any time in the past, individuals and families experienced ever-increasing risk, volatility and instability. Risk has, it seems, increased in every dimension. Income inequality has grown substantially, in part because income mobility has increased, but also because lifetime income has become more risky. Short term variability in income has also increased.


This is a surprise. Since aggregate income Is just the sum of all individual incomes, it would seem that an increase in individual risk should translate into an increase in the riskiness of aggregate income, even allowing for the fact that some gains and losses will cancel out.


Economic analysis of the paradox came to the conclusion that the development of financial markets had weakened links between economic variables such as income and consumption. Faced with a decline in income, households could borrow to maintain their consumption levels. As a result, the flow-on impact of a shock in one sector of the economy to consumer demand for the economy as a whole was reduced. This meant that high levels of volatility in individual incomes could co-exist with aggregate stability.


But, was such a pattern sustainable? If variations in income are transitory, then borrowing to maintain living standards through a rough patch makes sense. But responding to a permanent decline in income by going into debt is a recipe for disaster. And it’s obviously difficult to tell in advance whether an income decline is going to be temporary or permanent.


Not surprisingly, as income volatility increased, so did the number of people who got into trouble by relying on borrowing. The most direct measure is the number of people filing for bankruptcy. This has increased in most English-speaking countries, but nowhere more than in the United States. In the early years of the 21st century, more than 2 million people declared bankruptcy every year. In fact, in these years, Americans were more likely to go bankrupt than to get divorced. The commonest immediate causes of bankruptcy were job losses and unexpected health care costs. But the underlying cause was a culture of indebtedness which meant that most people who experienced financial stress rapidly ran into trouble meeting existing commitments.


In 2005, the credit card industry hit back at the rising bankruptcy rates with the Bankruptcy Abuse Prevention and Consumer Protection Act, which put a number of obstacles in the path of people seeking to resolve their debt problems through bankruptcy. In the year before the law came into effect, over two million households rushed to file. In the months immediately following ‘reform’, bankruptcies dropped almost to zero, and remained well below those of the pre-reform period for several years. But the pressures of increasing debt meant that many people had no choice but to negotiate the newly established obstacles to declaring bankruptcy, and the numbers doing so gradually increased.


The onset of the financial crisis was initially reflected more in foreclosures than in bankruptcies. Most mortgages in the US are (legally in some states and de facto in others) non-recourse, which means that, after foreclosing on the house offered as security creditors cannot go after the other assets of the borrower. This means that, even if a foreclosure yields far less than the amount owed, the borrower’s obligations are discharged. For this reason, as long as the crisis was primarily confined to housing markets, bankruptcy rates rose only gradually. But, with the onset of high unemployment, and the end of easy access to credit of all kinds, bankruptcy rates soared in early 2009. It now seems likely that the number of bankruptcies in 2009 will be more than 1.5 million, exceeding all previous years, except for 2005 when people were rushing to beat the deadline of bankruptcy reform.


Despite the volatility of individual income, and the risks of relying on credit markets, economists focused on macroeconomic aggregates continued to celebrate the Great Moderation right through 2007. 2008 came as a rude shock.






#


The GFC


The Great Moderation has vanished with surprising rapidity, though in retrospect its unsustainability has been evident since the late 1990s.


Bernanke’s Great Moderation hypothesis was not the first claim that the business cycle had been tamed, and it is unlikely to be the last. Every sustained period of growth in the history of capitalism has led to the proclamation of a New Era, in which full employment and steady economic growth would continue indefinitely. None of these proclamations has been fulfilled.


But, even by the unexacting standards of past economic projections, the Great Moderation has been one of the more spectacular failures. The Golden Age of Keynesianism lasted three decades, and delivered big increases in living standards throughout the developed world.


By contrast, the Great Moderation in the US didn’t really begin until the end of the first Bush recession in the early 1990s, and almost collapsed in the dotcom crash of 2000. It was only the reckless monetary expansionism of Bernanke’s predecessor, Alan Greenspan, that reinflated the bubble economy of the 1990s, and paved the way for an even more disastrous crash a few years later.


It is clear that the global economy is undergoing a severe recession, which will generate a substantial increase in the volatility of output. But even the economy recovers in 2010, as is suggested by some optimistic forecasters, crucial elements of the Great Moderation hypothesis have already been refuted. Over the period of the Great Moderation, all the major components of aggregate output (consumption, investment and public spending) became more stable. By contrast, any recovery will be the result of a massive fiscal stimulus, with a huge increase in public expenditure (net of taxes) offsetting large reductions in private sector demand.


The crisis has also invalidated most of the popular explanations for the Great Moderation. As will be discussed in more detail in Chapter …, the idea that improvements in monetary policy have been a force for economic stabilization looks rather silly, now that a crisis generated within the financial system has brought about a crisis against which the standard tools of monetary policy, based on adjustments to interest rates, have proved ineffective.


It is to the credit of central banks that, when their standard tools failed, they were willing to adopt more radical measures such as quantitative easing (that is, printing money and using it to purchase securities such as government bonds and corporate paper). Such radical steps, which contrast sharply with the passive response to the financial shocks of the Great Depression, have helped to prevent a complete meltdown of the financial system. But willingness to abandon failed policies does not change the fact of failure.


But if the pretensions of central banks have been shaken, those of financial markets have been utterly discredited. There is now no reason to give any credibility to the view that financial markets provide individuals and households with effective tools for risk management. Rather, in aggregate, the unrestrained growth of financial markets has proved, as on many past occasions, to be a source of instability and not a stabilising factor.


Just as the failure of the efficient markets hypothesis has destroyed much of the theoretical basis of the policy framework dominant in recent decades, the collapse of the Great Moderation has destroyed the pragmatic justification that, whatever the inequities and inefficiencies involved in the process, the shift to economic liberalism since the 1970s delivered sustained prosperity. If anything can be salvaged from the current mess, it will be in spite of the policies of recent decades and not because of them.



#


China and India


In the wake of the GFC, some advocates of economic liberalism have sought to shift the ground of debate, arguing that, whatever the impact of financial globalisation on developed countries, it has been hugely beneficial for India and China which, between them, account for a third of the world’s population.


There are all sorts of problems with this argument.


The relatively disappointing economic performance of China and India in the postwar decades certainly provides strong grounds for criticising the economic policies of Mao Zedong and Nehru. But even in the days when some observers saw these policies as providing an appropriate development path for the countries that adopted them, no one seriously proposed their adoption by developed countries. And as more attention has been focused on the irrational aspects of these policies (such as the Great Leap Forward, in which people were made to melt down their cooking pots to provide scrap for backyard smelters, which presumably produced new cooking pots, or the dozens of licenses required to undertake the simplest economic activity in India) it has become easier to understand why their removal or relaxation


At the same time, neither of these rapidly-growing economies come anywhere near meeting the standard description of a free-market economy. China still has a huge state-owned enterprise sector, a tightly restricted financial system and a closely managed exchange rate. India began its growth spurt before the main period of market liberalisation and also retains a large state sector. In both countries, as earlier in Japan and South-East Asia, the state has played a major role in promoting particular directions of development.




In summary, while the development success stories of China and India, and, before them of Japan and the East Asian tigers, may have some useful lessons for countries struggling to escape the poverty trap, they can tell us nothing about the relative merits of economic liberalism and social democracy.


{ 35 comments }

1

Mg 08.24.09 at 12:27 pm

Paul Krugman had an Op-Ed out in the NYT today, entitled “All The President’s Zombies”.

“Call me naïve, but I actually hoped that the failure of Reaganism in practice would kill it. It turns out, however, to be a zombie doctrine: even though it should be dead, it keeps on coming…

So why won’t these zombie ideas die?”

I see JQ’s viral publicity campaign is underway.

2

Kenny Easwaran 08.24.09 at 12:51 pm

When you discuss the debate about whether Hayek or von Mises is the best idol for Austrian economists, you don’t say which of the ideas that follow are associated with which branch of that debate. I suppose it’s a minor point, but interesting at least for intellectual history.

Also, when you say that the Great Moderation didn’t really begin until after the 1990 recession, this seems to contradict what you said earlier about it beginning in the early ’80s. Is there a reason for this change? It’s not explained here.

3

Salient 08.24.09 at 1:57 pm

But if the Austrians agree on the evils of central banking, they disagree on almost everything else. Some, endorsing the judgement of the mainstream economists who awarded Hayek the Nobel prize in economics, see him as having far surpassed the initial contributions of his teacher von Mises. Others see von Mises as the true source, and his American student Murray Rothbard as his intellectual heir. [paragraph break] The disagreements don’t stop there.

Having a hard time seeing why, as a layperson, I should bother to familiarize myself with the above disagreement. If there’s some compelling reason for me to track who is whose heir here, please elucidate.

Every sustained period of growth in the history of capitalism has led to the proclamation of a New Era, in which full employment and steady economic growth would continue indefinitely. None of these proclamations has been fulfilled.

This would be the best introductory paragraph to this section that any human being could ever write, and it’s a shame it’s buried in a late paragraph.

4

Akhila Aiyer 08.24.09 at 2:45 pm

Great work! I had a tough time navigating through references. Hopefully, there will be some extent of detail elsewhere in the book for people like me.

Perhaps it’s a built in characteristic of the collective human psyche that we swing from extreme optimism to extreme pessimism. Then a truly free market captial system would tend to swing to extremes as well. If we skip the last 75 years and look at history, short sharp bursts were the norm. What acts as brakes on the pendulum swing phenomenon in the modern financial system is “the perceived effectiveness or super abilities” of monetary policy. Such perceptions are granted by an observer or participant of the capital markets to a truly strong currency whose capacity to act as a shock absorber is massive and extends into a significant time frame, ideally into perpetuity. So in a current situation where the dollar, the reserve currency of the world is not so strong, and the underlying economic and fiscal realities backing the currency are pointing to an obviously unsustainable structure , ” the perceived abilities” of the shock absorber becomes questionable. The loss of this perception of the “all powerful shock absorber” has unleashed the wild swing that had been contained for so many years. We should be expecting more such wild swings to return. The only alternative is that there is a new set of financial regulations and the creation of new reserve currency.

Any new system that is created will be effective if only it has the capacity to restrict the ability of the current generation to make promises of and indebt future generations. Promises made into the future that cannot be honored underly the destruction of any financial system including the one we are witnessing today.

5

Colin Danby 08.24.09 at 4:14 pm

It does seem that the discussion on Austrianism spends more time than it needs on internal disagreements and less than it should on positive contributions. Minsky at least gets some positive exposition, which is to say there’s an effort made to explain why some folks might find him persuasive. That effort seems worth making for Austrian economists too.

At the risk of undermining the above, though, Minsky is put in a framework that ignores the Post Keynesian rejection of “fundamental” asset values from which asset prices diverge. Given *fundamental uncertainty* and an unmade future, there’s no distinction between fundamentals and sentiments. Fundamental uncertainty would also deny the possibility of prediction; the relevant standard would be whether Minsky and his followers had a good grasp on institutional vulnerabilities. The presentation above ignores the bases of PK dissent and reduces Minsky to a description of weak regulation. It might be worth glancing again at Minsky’s _John Maynard Keynes_. And at the risk of exasperating general readers, the absence of microfoundations is not a bug but a feature. See e.g. the Critical Realist literature on social ontology.

6

Chris 08.24.09 at 6:28 pm

It does seem that the discussion on Austrianism spends more time than it needs on internal disagreements and less than it should on positive contributions.

Does Austrianism *have* any positive contributions? I got the impression that JQ thought he should say something about the Austrians, didn’t have anything particularly favorable to say, and so recited some relatively uncontroversial facts about the different schools of thought within Austrianism, and that the only reason he didn’t say something like “It was [the Austrians | name of particular Austrian] who first pointed out that…” is that he couldn’t truthfully finish the sentence with a useful idea confirmed by data. (IMO, if the Austrians *did* contribute usefully to understanding of some economic phenomenon, then leaving this impression is unfair and you should probably avoid it, unless my interpretation is idiosyncratic and most people don’t read the passage that way.)

This leads directly to the idea that the Austrians’ suspicion of the bubble was of the stopped-clock variety of correctness, while the Keynesians have been right several times in *different* ways and may be on to something.

7

Colin Danby 08.24.09 at 7:58 pm

Chris, I’m not the best person to make the case for Austrian econ, but certainly figures like Lawrence White and Roger Garrison have written on the current crisis, and I don’t think it would be too hard to work forward from Hayek’s writings on money and finance. I’d have no difficulty defending the positive contributions of folks like Don Lavoie and Israel Kirzner to understanding economic phenomena in general.

(Is the bat signal working? Any Austrians out there who want to chime in?)

One might also note the absence of any mention of Marxian work.

I dunno — I suppose I should be pleased to see any mention of heterodoxy, however perfunctory, but as written this is not so much an acknowledgment as a gesture of containment: a quick dismissive sketch which doesn’t acknowledge fundamental critiques, and then back to the program. Let me be clear that I really like JQ’s work and the book will be valuable, but it’s wholly mainstream.

8

Ahistoricality 08.24.09 at 7:59 pm

Following on the above comments, you explain how Minsky’s ideas connect to and explain our current predicament, but not how the Austrian’s ideas about the central banks have any relation. I know libertarian economists think the Fed is the evil, but bumbling, genius behind our troubles, but what supports that?

9

Sebastian 08.24.09 at 10:24 pm

“The Golden Age of Keynesianism lasted three decades, and delivered big increases in living standards throughout the developed world.

By contrast, the Great Moderation in the US didn’t really begin until the end of the first Bush recession in the early 1990s, and almost collapsed in the dotcom crash of 2000. It was only the reckless monetary expansionism of Bernanke’s predecessor, Alan Greenspan, that reinflated the bubble economy of the 1990s, and paved the way for an even more disastrous crash a few years later.”

Do we really know or have strong reason to believe that Keynesianism is what delivered big increases in the living standards throughout the developed world? Could it have been largely non-economic policy changes like the integration of women into the workforce or the rise of inter-state trucking (in the US and Australia) or increased international trade in general?

10

John Quiggin 08.24.09 at 10:35 pm

Thanks for these comments. I definitely need to talk more about fundamental uncertainty (there’s a bit of a mention in the financial markets chapter, and I plan some in the chapter on macro theory too). And I agree that the lack of microfoundations (at least microfoundations consistent with standard microeconomics) is a feature not a big. The hinted-at chapter is a critique of micro-based macro.

11

Jim Harrison 08.25.09 at 1:31 am

Assyrian intellectuals probably argued whether it was the sacrifices to Marduk or the homage paid to Ishtar that accounted for the military successes of their empire. While a great many factors account for the enormous growth of the American economy after WWII, surely the fact that we hadn’t been bombed and invaded and the emergence of new technologies had more to do with the boom than any economic theory, especially when you take into account that not American administration, even FDR’s, actually followed the Keynesian prescription.

Thing is, each nation after 1945 had the potential for a boom and when that boom occurred each explained it by pointing to whatever ideological notions were current at the time it happened. On the other hand, I’m inclined to think that application of rigid economic theories does explain the bad performance of some economies: the USSR after 1960, the U.S. after 1980, for example.

12

Anthony 08.25.09 at 1:55 am

The article introduces the Austrians by saying that they said the booms were unsustainable, then digresses into internal disagreements among the Austrians, without ever discussing a single Austrian idea. Sure, the Austrians said that the unsustainability was caused by government intervention, particularly in the form of central banking, but there’s plenty of Austrian literature which explains how central banks create unsustainable booms, and how they frequently (but apparently not always) have the ability to delay the inevitable reckoning past an election, which could be summed up in a paragraph about as long as the paragraph on Minsky.

Doing the (rather minimal) research neccesary to actually write that paragraph is left as an exercise for the writer.

13

Martin 08.25.09 at 2:44 am

This is the first entry I’ve made time to read. However, my comment goes to organization and exposition and may apply to your other topics as well.

You appear to start in assuming that your reader knows what “the great moderation” or, perhaps better, the “great moderation thesis” is. I suspect that in practice most of your prospective readers will have heard of most of your topics, but many will have, at best, a soundbite understanding of them.

You might consider starting with a short potted exposition of what “the great moderation” (or the other theories and theses you address) was, with a reasonably sympathetic explanation of why reasonable people believed in it and may still believe in it or be tempted (for good reasons) to believe in it. There is a risk that repeating this pattern will make your book boring. However, it may help non-economists understand your arguments at more than a superficial level. In addition, it might help make clear that you are not just setting up straw persons. Finally, it might help clarify the organization of your critical arguments by explicitly defining the targets you are criticizing.

14

Down and Out of Sài Gòn 08.25.09 at 3:27 am

And as more attention has been focused on the irrational aspects of these policies (such as the Great Leap Forward, in which people were made to melt down their cooking pots to provide scrap for backyard smelters, which presumably produced new cooking pots, or the dozens of licenses required to undertake the simplest economic activity in India) it has become easier to understand why their removal or relaxation

And then the sentence ends abruptly. Are there meant to be more words here?

15

Thorfinn 08.25.09 at 3:49 am

(response from earlier): Right; the financial crisis is endogenous to the degree of financial deregulation, but is exogenous to the supply-side innovations in logistics that seem to have genuinely lowered volatility. The oil shock was presumably exogenous too, and would have by itself probably have caused the current bad conditions in an earlier decade. You are right of course to say that this does not suggest–as Romer, Bernanke, and Greenspan have tried to argue–that policy has gotten better.

On risk sharing, Jensen and Shore find that the increase in volatility is due largely to subpopulations with a higher propensity for risk. It’s the high income deciles that are driving the increase in volatility. Consumption inequality has also far trailed income inequality. I’m sure you disagree, but the book will read better as a response to the best opponents, rather than strawmen.

http://www.aeaweb.org/annual_mtg_papers/2009/retrieve.php?pdfid=204
http://research.stlouisfed.org/publications/net/20081001/cover.pdf

I’m surprised to see such hostility against Australian policymakers. My understanding was that their financial regulations were much better thought-out (and overall, they seem to be growing on trend for decades on end). You might want to look at (if you haven’t already) Texas’ housing regulations–among other laws, a homestead law from the 1800s virtually prevented subprime loans, and they have many fewer foreclosures today, and little in the way of a bubble. Vermont chased those lenders out as well (but missed out on the (illusory) boom).

I confess I don’t see the broader takeaway (though I agree with many individual points on particular policies). Should we be more Keynsian? Didn’t we spend the last eight years doing that? You can say “Kenyes wouldn’t have advocated those policies”–but it seems that if Keynes was correct, the last several years should have been much better than they were.

16

Francis Xavier Holden 08.25.09 at 6:00 am

When I scan I keep thinking The Austrians reads as The Australians. I think you should work this into a title.

Zombie Economics: An Australian takes on the Austrians.
Zombie Economics: An Australian’s take on the Austrians.
Zombie Economics: You say Austrian I say Australian – lets call the whole thing off.

17

Stuart 08.25.09 at 12:17 pm

You appear to start in assuming that your reader knows what “the great moderation” or, perhaps better, the “great moderation thesis” is.

So the writer is assuming the reader has read the earlier part of the chapter? I think that is a reasonable assumption to write a book under.

18

JoB 08.25.09 at 12:27 pm

John,

This is how you end:

“they tell us nothing about the relative merits of economic liberalism and social democracy.”

But imho, you didn’t tell us a lot either. You make a passing comment on Austrians and seem to lump anything Keynesian into social democracy (and all economic liberalism into Austrians), & all of it seems more a settling of scores than an attempt at novel insights (by writer or readers).

Clearly you can have a government-dominated economy which is anti-social and undemocratic. It was in fact a central theme of the Von’s that a government-dominated economy necessarily & of itself led to undemocratic government. I think they were right up to a point, and I don’t think Keynes can be quoted anywhere near as ‘social-democratic’ as you’d like to have him (and as I’d like to have him for that matter). After all – the essence of Keynesianism was that government is to be an actor, certainly not a dominant actor on the average. Leaving that unqualified – as it was pre-Austrians is a dangerously economy-as-the-goal-in-itself statement. Qualifying it – even if overqualifying it- was the merit of the Austrians.

What you talk about is Thatcherite Reaganomics: leverage power of a few oligarchic individuals by lowering their taxes and deleveraging all other plebeian individuals in the strongly autocratic state of conservative ethics. It’s the politics that are essentially wrong, the economics were only instrumentally wrong. Both by the Austrians that were too rigorous in their anti-government (& too gullable in front of the politicians that abused their intellectual work) and by the Keynesians who think that we should remain forever in some orthodoxy on government as the prime mover (even if none of them dear to say nationalizing telecommunications would be a good thing).

Maybe it is because neither Australians nor Americans know what Europe was like in the 70’s & 80’s, & in the early 90s, that you are so optimistic about the policies of those times – & so easily dismissive of the work of some clearly liberal authors that happened to be Austrian (and not by chance that they happened to be Austrian as well).

19

Barry 08.25.09 at 12:58 pm

“You might want to look at (if you haven’t already) Texas’ housing regulations—among other laws, a homestead law from the 1800s virtually prevented subprime loans, and they have many fewer foreclosures today, and little in the way of a bubble. “

Somebody somewhere on the internet, while trashing Douthat’s latest dump, said that Texas tightened lending regulations quite a bit after having a bubble and collapse in the 1980’s (from other reading, ISTR that a disproportionate chunk of the failed S&L’s were Texan).

20

Chris 08.25.09 at 1:56 pm

#18: all of it seems more a settling of scores than an attempt at novel insights

Isn’t that the point of the whole book? To bury these ideas at the crossroads with a stake through their hearts so that they won’t rise again to devour the brains of economists and pundits?

It’s the politics that are essentially wrong, the economics were only instrumentally wrong.

Economics as an applied science cannot be depoliticized. The free-market solution to poor people who need expensive health care is to let them die because it’s economically inefficient to keep them alive. (In earlier historical times, that was also the solution to the problem of poor people who need food. Food is now cheap enough in the industrialized world for that to be less of a problem, provided you don’t insist on it being *healthy* food, but health care is not, and seems unlikely to become so.) That is the optimum which the market will seek in all its Hayekian collective-wisdom optimizing glory – at least, until the supply of labor declines enough to raise its market value.

This leads to political instability for rather obvious reasons. The question of how highly to value efficiency and maximum output compared to other goals (such as human life, or societal perceptions of fairness by any of a wide variety of standards) is a political one, and depending on how it is resolved, may make academic questions of economics irrelevant.

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belle le triste 08.25.09 at 2:29 pm

The writer is assuming the reader has read the earlier part of the chapter? I think that is a reasonable assumption to write a book under.

The (zombie) tradition of all dead-tree media weighs like a nightmare on the brains of the living internet.

22

JoB 08.25.09 at 3:20 pm

Chris-20,

To be honest, the point is not that clear. I have no issue with polemical stuff (as suggested by a Zombie-referring title) but then I’d expect some fun & games to go with. As this chapter goes, I think the only really deadly stuff except from the title is the seriousness. But, if wholly serious, then the standards are different.

For instance: yes, no economics cannot be depoliticized. So you don’t get easy caricature on a bunch of Austrians without also allowing easy cariciature on socialism. I disagree sincerely on most things with Hayek, but his point was not that economy should be left alone because it is an end in itself. His point was that government is very dangerous if it alone determines what has to be produced by the economy.

To dismiss everything Austrian in a polemical way is fair enough given what happens now – but to dismiss it seriously as entirely & utterly wrong in every principle is counterproductive (in an attempt to limit myself to more neutral words).

(& no, the Austrian element – however much of a waving red piece of cloth it may be to some of the wandering bulls over here – was not the main information element in my reaction)

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JoB 08.25.09 at 3:22 pm

Chris-20,

(resubmitted removing the ‘offensive’ term)

To be honest, the point is not that clear. I have no issue with polemical stuff (as suggested by a Zombie-referring title) but then I’d expect some fun & games to go with. As this chapter goes, I think the only really deadly stuff except from the title is the seriousness. But, if wholly serious, then the standards are different.

For instance: yes, no economics cannot be depoliticized. So you don’t get easy caricature on a bunch of Austrians without also allowing easy cariciature on soc1al1sm. I disagree sincerely on most things with Hayek, but his point was not that economy should be left alone because it is an end in itself. His point was that government is very dangerous if it alone determines what has to be produced by the economy.

To dismiss everything Austrian in a polemical way is fair enough given what happens now – but to dismiss it seriously as entirely & utterly wrong in every principle is counterproductive (in an attempt to limit myself to more neutral words).

(& no, the Austrian element – however much of a waving red piece of cloth it may be to some of the wandering bulls over here – was not the main information element in my reaction)

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Chris 08.25.09 at 5:41 pm

His point was that government is very dangerous if it alone determines what has to be produced by the economy.

That’s not much of an attempt at a novel insight, either. (Or did he write so long ago that it actually was?) There is a large middle ground between government having no control over an economy and government having total control, a middle ground which many wealthy, high-tech countries comfortably inhabit. Raising the specter of totalitarianism every time any government intervention, no matter how small, is proposed is a fundamentally dishonest tactic. “Government as the prime mover” is a blatant strawman.

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spencer 08.25.09 at 7:44 pm

Maybe I have missed it in earlier sections, but I find it hard to accept an explanation of the great moderation that does not include any references to inflation.

Another way of looking at the post WW II era:
1950s– great volatility, 3 recessions as Fed deals with problems of post WW II,
Korean War inflation.
1960s — stability and strong growth maybe partially because of success of 1950s anti-
inflation program. No need for Fed to tighten, no recession in 1967, just a
growth recession.
1970s– return of inflation and volatility as had four fed induced recessions to fight inflation.

1980s– Volcker anti-inflation success set stage for strong growth without inflation.
1990s recession mild because it was not fighting entrenched inflation.
1990s– weak growth, but still no need to fight inflation. But because of success of anti
inflation measures attitudes changed — high stock market PE and cheap or at
times free capital created tech bubble.
2000– end of bubble, but surprisingly mild recession. Still no problem with inflation.
cheap capital continued and flowed into housing bubble. Difference between
US & Japan is Japan had both bubbles concurrently, US sequentially.

See, I can build a good story about the great moderation around Fed policy and
inflation with little need for other factors like improved productivity, etc.
The combination of cheap capital and low inflation set stage for the two
bubbles and the over expansion of the financial sector in taking on a new level
of risk that set the state for the financial panic at the end of the expansion.

I built a very nice PE model that makes PE partially a function of time since
prior bear markets that does good job of explaining 1990s high PE.

I think you need to incorporate these two key points into your analysis.

26

John Quiggin 08.25.09 at 10:07 pm

I agree with several commenters that I need to do a better job explaining what the Austrians are actually about, instead of just snarking. I had a go at this a while ago and I’ll try to distil it to a para or two.

But, I’m struck by this from JoB

It was in fact a central theme of the Von’s that a government-dominated economy necessarily & of itself led to undemocratic government. I think they were right up to a point

It was a central theme, but one on which they were proved utterly wrong. I’m amazed at the extent to which a book like The Road to Serfdom is taken seriously when the only possible defence is turned all of its unqualified “necessarily & of itself” claims into weak and conditional hypotheses, where the conditions turned out (in some unexplained way) not to be satisfied. But you seem to be suggesting the Europe is, in fact, in a state of near-serfdom – maybe you could spell your points out a bit.

On inflation, this was supposed to be implicit in the contrast between the failure of the Keynesian Golden Age and the apparent success of monetary policy in the Great Moderation, discussed in the causes section (my previous post). I’ll look at spelling this out a bit more.

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Martin Bento 08.26.09 at 5:03 am

“A statistical test suggesting that the economy was much more volatile in the 1950s and 1960s than in the 1990s is hard to accept in view of the actual experience of the postwar boom as a period of strong growth and low unemployment. If measures of volatility contradict this experience, the obvious response is to suggest that they must not be measuring the right thing.”

Is there a good reason to believe that average magnitude of growth over course of the business cycle and volatility are necessarily inversely related? Could not faster growth with low unemployment lead to more frequent reversals while still producing higher growth on average? Maybe the simplest explanation of this piece of data is that decreasing volatility does not necessarily increase growth.

And if so, perhaps there should there be a section on What’s So Great About Moderation? By which I mean, the claim I remember advocates of neoliberalism making from the time of Reagan on is that their policies would create higher levels of growth and raise living standards overall. I don’t remember anyone saying: “Well, growth won’t be as high as in the days of high taxes and intrusive regulation, but it’ll be real smooth”. The last time it was possible to believe that neoliberalism would produce widespread prosperity was the late 90’s, when it seemed to come true for a minute. After the crash, it was clear that the Keynesian era had produced greater prosperity, but Bernacke looked back over the data and found that there had only been two brief recessions during the neoliberal period. All of a sudden, that had been the goal all along! This doesn’t look like a metric the neoliberal period met; it looks like one that was cherry-picked after the fact to flatter it.

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JoB 08.26.09 at 7:55 am

John,

Nope, I was not suggesting Europe is in a state of near serfdom, nor is Europe (after decades of predominantly Austrian influences) by any means social-democratic in your sense (which is an item that you and others (and I) decry often enough to take it for granted).

In Europe government dominated much about everything in the 70s and it was not a good place for it whatever you retrospectively may tell about it. The establishment ruled, and there was no penetrating the establishment – the origin of current enti-establishment right wing parties here – that connected to traditional US right wing – stems from that ‘checked’ society.

In the meantime, we did privatize what should be privatized (& unfortunately also a lot of things that should not have been). The power balance is healthier – and we did maintain levels of public services and social security that outperform those in any other continent.

The lithmus-test on ‘completely & utterly wrong’ is, John, whether you’d advocate nationalizing telecommunications industries. If yes, your social democracy is not mine. If no, you’ll just have to conceed something to the Austrians.

(and again, in a polemical way – no issue to slam them – no issue to slam Chavez as well despite a couple of things he did that needed doing; but in seriousness, these were intellectuals that had a couple of ideas, liberal ideas, and it’s just dishonest to accuse them of what actually went wrong after they were well and truely dead)

Whether you like it or not the third way already exists despite the dishonour of somebody like a Tony Blair being wrongly associated with it.

Chris, the strawman is yours – they weren’t no-government anarchists and dead enough for long enough not to be personally accountable for 21st century bubbles (the novelty can be disputed, I guess, but are you then committing yourself to saying orthodox Keynesianism was challenged by nothing – thát would be a blow to John’s book ;-)

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John Quiggin 08.26.09 at 12:07 pm

Without wanting to make a general claim about telecommunications, privatisation in Australia has been a disaster to the point where the (very centrist) Labor government has announced the creation of a new publicly-owned network, effectively renationalisation. So yes, we will have to disagree on this one.

As regards the Third Way, Keynesian-welfare state social democracy was genuinely a Third Way, transcending the debate between old-style socialism and laissez-faire. What Blair offered was just a half-baked compromise between social democracy and market liberalism, a fact that has become more and more evident over time. The claim of a third way was pure spin.

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Chris 08.26.09 at 2:08 pm

It was a central theme, but one on which they were proved utterly wrong. I’m amazed at the extent to which a book like The Road to Serfdom is taken seriously when the only possible defence is turned all of its unqualified “necessarily & of itself” claims into weak and conditional hypotheses, where the conditions turned out (in some unexplained way) not to be satisfied.

ISTM that their claim is right in the strict sense, but you have to be careful not to overapply it and classify as “government dominated” an economy which is, in fact, merely government influenced or government regulated. Truly government dominated economies – i.e. command economies with five year plans etc. – really are accompanied by undemocratic government.

But central banks are not a slippery slope that inevitably leads to command economies – the continuum of degrees of governmental involvement in the economy is, in fact, neither sloping nor slippery, as the history of several countries proves quite clearly. Unfortunately, neo-Austrianism seems to consist mainly of arguing that rather modest forms of government influence are actually totalitarianism in disguise. (I have to admit that I haven’t read _tRtS_ myself, so I don’t know if this common error is repetition of an error also made by the founders of the school.) There’s only so many times you can cry wolf at every passing rabbit before people stop taking you seriously.

Or, IOW, serfdom may indeed lie at the end of that road, but there’s some quite nice places in the middle and you can stop anywhere you like or even walk back the other way. And the *other* end of the same road is anarchic warlordism, which isn’t so nice either. Saying that anyone who wants to take one step along that road (in either direction) necessarily wants to rush to the endpoint is dishonest, unless you have some specific proof that that is what they do want (in which case you are obliged to present it and not merely insinuate).

P.S. Aren’t communications networks a natural monopoly because of the network effect? ISTM that they *must* be, at least, carefully regulated and it would be insane to do otherwise. Where would phones or the Internet be without government-developed and -enforced interoperability standards? Ownership seems like a red herring if you’ve already conceded the necessity of state control.

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JoB 08.26.09 at 3:41 pm

John,

I searched myself crazy to find evidence of your claim in renationalization. Unless you have a magical reference that I can’t find you misinterpret a desire to establish the equal competitive access to a National Broadband Network with renationalization (i.e. with regulation). Telstra’s private, Optus is private and Australia has (like the rest of the West) a competitive landscape of communications providers, that is still dominated by previous state owned monopolists (which is why, certainly in a lower density region such as big chunks of Australia) government steps in, not to nationalize but to ensure the effective breaking of its previous monopoly. To Chris’ point as well: communications networks have some characteristics of natural monopolies but not too much, not like water or electricity by any stretch of the imagination. If we’re having this talk, & having it with relative ease, it is precisely because of privatizations; there’s not a chance in hell a Telstra would have delivered broadband if unchallenged (they might have given you B-ISDN or something ITU-like but not broadband or anything IETF-like).

The idea of somebody like Quigley leading a charge for nationalization is, if you’ve met him, one of the least natural to have.

On the other thing:

Well, I separated myself from Blair so putting me back in that cage is not very friendly.

I typed ‘Keynesian-welfare state social democracy’ in google and came up with this:

http://oud.frankvandenbroucke.be/html/soc/PU000117.htm

(which is nice because he’s Flemish, like me, and I tend to disagree with him on most things)

You present this 5-word string as if it’s something self-evident and self-evidently demarcates in a strict way between social-democrats and Austrians (or economic liberal ideas in general) – and that’s, I’m more & more convinced, just not on.

I quote from the link:

I cannot go through all the arguments here, but let me put it as follows. The identification of “classical social democracy” with “effective Keynesianism” relies on hidden assumptions, which are too easily taken for granted. Once, so it is assumed, we lived in a “golden age” during which, first, the appropriate policy for social democrats confronted with unemployment was in all circumstances some mixture of fiscal and monetary demand expansion organized by governments, and second, Keynesianism, so conceived, was essentially unproblematic in less open economies. Neither of these assumptions is true (4).

This at least demonstrates (and yes it’s from 2001, but Frank’s still a social democrat and I don’t think he’s very much changed his views on this) that the relation ‘Keynes & social-democracy’ is not as simplistic as you say. Sure, the anti-Keynes reaction was too vehement – and in part led to what we’ve seen lately. Sure, seen from the US (and most of Europe – as of recently) we need the governments to be stronger (certainly the international government, see I’m a real ‘soc1al1st – I have not problem with the ‘international’). But we also need to realize that ‘open economies’ and the reduction of the power of ‘representative middle field’ has its advantages. So it’s neither – or it’s both – whatever you want but if you’re serious it’s certainly not the one or the other.

PS: if there is a Keynesian third way it presumably dates from after Keynes and presumably has integrated something which did not come from Keynes – so whence did it come from? Might it, I don’t find this as a term known in the general public, per chance have integrated economically liberal ideas related to the use made of the term ‘open’ by Austrians?

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John Quiggin 08.27.09 at 2:31 am

JoB, we seem to be talking at cross purposes. The National Broadband Network is to be built with (a lot of) public money by a government owned company. That counts as nationalisation in my view. It’s true there’s a plan for an eventual reprivatisation, but I don’t think

On Keynesian social democracy, I agree all this is problematic, but I’m trying to sum up, very quickly, the package of ideas that was displaced by market liberalism. As your quote indicates, the received view of proponents at the time was that these things fitted together very well. The fact that they failed in the 1970s makes it obvious that there are problems and I plan to talk a bit more about this in some other chapters.

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JoB 08.27.09 at 7:55 am

John, OK then but you’re definitely wrong on the NBN (rather you’re reading it in a way that’s fitting your scheme), I read more, I think it’s just bad policy: to get universal broadband in the rural areas will always be costly but to do it this way is monstrously monoloithic.

Fair enough on ‘problematic’ but I stand by my basic input that you have to choose polemical or serious. If the latter, then even for a broad audience, you should not dichotomize.

34

aaron 08.27.09 at 8:20 am

I have not read any of the “bookblogging” entries yet, so hopefully my concerns do not simply repeat those from elsewhere. Much of what you say is very interesting, but raises more questions than answers. My input here is limited to two areas I find particularly perplexing to economists, business cycles and productivity growth.

Business cycles are a fairly controversial topic (debate about them mirrors that about the great moderation in many ways), and perhaps one that should be elaborated on a little more extensively. Since they are often currently modeled as “shocks” (including in Minsky’s approaches) and a traditional understanding of business cycles is less credit-driven, I’d argue that you’d do a service to your readers by preventing them from simply believing in “the business cycle” but instead calling it into question.

Second, I think the statistical argument against the “great moderation” is unconvincing, as you yourself point out that the methodology is flawed in the first place. But the real argument against the great moderation theory appears to be in chapter … However, I think it’s fair to wonder whether the recent crisis renders the “great moderation” bogus, in much the same way that the oil crises of the 70s supposedly demonstrated the ineffectiveness of Keynesianism.

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Robert 08.27.09 at 3:19 pm

I might as well point out I have a refutation of Austrian Business Cycle Theory. My name links to my SSRN page, where I have various versions.

I think interesting Post Keynesian proposals for incomes policies during the 1970s. I don’t think anybody has shown the economic theory behind these to be mistaken.

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