A little bit I plan to include in the chapter on the Great Moderation, linking on to a critique of post-70s macroeconomics. As always, comments and criticism gratefully (and, mostly, I hope, gracefully) accepted
The failure of the Great Moderation calls for a rethinking of the macroeconomic experience of the 20th century, and, in particular, the crisis of the 1970s. Considered as a whole, the performance of developed economics in the era of market liberalism looks considerably less impressive than that of the postwar period of Keynesian social democracy.
Yet the Keynesian era ended in the chaos and failure of the 1970s. Until the current crisis, that failure was widely taken as conclusive. Whatever its merits, it seemed, Keynesian economic management had proved unsustainable in the end, while the methods of market liberalism seemed to promise the continuing stability of the Great Moderation.
That view can no longer be sustained. The Great Moderation has ended in a failure at least as bad as that of the postwar boom. And, if there is a recovery, it will be due to the very measures that market liberalism was supposed to have rendered obsolete. How then, should we think about the Keynesian era and its failure?
One possible interpretation, a pessimistic one, is that business cycles are so deeply embedded in the logic of market economics (and, perhaps of all modern economies) that they cannot be tamed. Success breeds hubris, and hubris leads us to ignore the lessons of the past: that resources are always constrained, that budgets must ultimately balance, that wages and other incomes cannot, for long, exceed the value of production and so on. It the 1960s, this hubris manifested itself in the wage-price spiral. In the 1990s and 2000s, it was seen in the speculative frenzy unleashed by the self-styled Masters of the Universe in the financial sector.
But this is not the only possible interpretation. Perhaps the failures of the 1970s were the result of mistakes that could have been avoided with a better understanding of the economy and stronger social institutions. If so, the current crisis may mark a return to successful Keynesian policies that take account of the errors of the past.
The end of the Great Moderation has forced policymakers to relearn the basic lessons of Keynesian economics. Economies can collapse to a point where only large scale monetary expansion and fiscal stimulus can revive them. But having revived the economy, can Keynesian policies restore and sustain full employment in a system that is inherently prone to crisis. To answer this question, we requires radical new directions in macronomics. As we will argue in the following chapter, that means the abandonment of yet more dead or obsolete ideas.
{ 14 comments }
P O'Neill 09.09.09 at 1:18 am
I think that this paper provides some important technical context for the discussion
http://www.federalreserve.gov/pubs/ifdp/2004/804/ifdp804.htm
And note that one of the authors has since gone on to be on the board of the ECB via Cyprus. Anyway, the paper can be read both as a justification for why Keynesian economics went wrong (bad data) but also an explanation for the Great Moderation (control of inflation expectations). Of course as we now know, the Great Moderation went off the rails without any obvious inflation problem (notwithstanding the 1970s style surge in oil prices, playing out on a slower time scale). But I suppose the question coming from this is: Knowing what now know, is 1960s Keynesian economics essentially intact?
lemuel piktin 09.09.09 at 2:05 am
I’m very curious, John: do you have a preferred explanation (or explanations) for business cycles?
John Quiggin 09.09.09 at 2:15 am
LP, I neither believe in cycles (in the sense of periodic movements) nor in a unicausal explanation for booms and slumps. But, in the absence of regulation and active macro policy, I see financial sector instability as a crucial factor in most bubbles and busts.
On the other hand, in the presence of active policy, the proximate cause of booms and slumps is generally policy failure of some kind.
The last decade has showed both factors at work, and interacting. A financial sector bubble and bust in the dotcom era, bailed out by expansionary monetary policy which allowed an even bigger bubble and bust requiring an even bigger bailout. It remains to be seen whether this will go on to a third act, or whether the finance sector will be brought under more effective control.
Kenny Easwaran 09.09.09 at 4:04 am
A minor point: The Great Moderation has ended in a failure at least as bad as that of the postwar boom.
That sentence sounds to me like you’re saying that the postwar boom was a failure. I assume that “that of the postwar boom” is supposed to mean “the end of the postwar boom”, but it sounds to me on first reading like “the failure of the postwar boom”.
Kenny Easwaran 09.09.09 at 4:04 am
I suppose you could say “The Great Moderation has come to an end at least as bad as that of the postwar boom.”
JoB 09.09.09 at 7:47 am
If you can show the link between dead ideas and radical new directions (i.e. also different from Keynesianism), you’ve got me hooked again.
I heard Greenspan just said on the BBC that he always said it was a bubble & that it would burst. And, to be safe, he says it will burst again. Meaning, I guess, “As you were! Carry On!” ;-(
Some cycles will be endemic, surely, any dynamic system displays sinusoidal movements. This idea of ‘controlling’ the system to be utterly well- behaved is imho nonsense. The question is, as you point out, whether our policies dampen or heighten the amplitudes and frequencies of such waves (and of course, ultimately whether they increase on the long term fairness of the whole – which includes at least in part the avoidance of heavy/fast waves and the avoidance of risks that are associated to these waves being pinpointed on the weak).
alex 09.09.09 at 9:04 am
Would it be wrong to think that some/many of the economic problems of the 1970s had nothing to do with economic management per se, but more to do with rapidly-changing global circumstances, and purely political unwillingness to pay the costs to reorient economies away from ‘metal-bashing’?
Stuart 09.09.09 at 12:33 pm
But this is not the only possible interpretation. Perhaps the failures of the 1970s were the result of mistakes that could have been avoided with a better understanding of the economy and stronger social institutions. If so, the current crisis may mark a return to successful Keynesian policies that take account of the errors of the past.
This seems fairly weak – seeing as there isn’t any evidence here to suggest this is a particularly viable interpretation, couldn’t you equally have highlighted other interpretations such as that the Great Moderation could have continued if mistakes had not been made and stronger social institutions were in place? Why this pick this particular alternative interpretation to highlight?
Barry 09.09.09 at 1:39 pm
John, what puzzles me (and which I can’t recall you mentioning in the previous chapters) is the Oil Crisis.
First, radical increases of the price of a basic commodity on which the world runs would be expected to hammer economic growth in most sectors.
Second, this would be expected to lead to a period of wild instability, until the world figured out how to handle it.
Third, that chunk of ~25 years of investment which were based on low oil prices would be ex poste far from optimal, and not in a good way.
If you were evaluating a sim which was expected to teach students about economics, and set the price of a major resouce to 3x the previous price, wouldn’t you expect a lot of stuff like we saw in 1973-82?
Tom West 09.09.09 at 5:56 pm
Economies can collapse to a point where only large scale monetary expansion and fiscal stimulus can revive them.
Not to challenge the point, but do we have any examples of larger industrial economies that did *not* engage in large scale monetary expansion and fiscal stimulus and thus are still collapsed?
Steve Kyle 09.09.09 at 6:08 pm
There are those fluctuations that come from the operation of the system with its ups and downs and then there are fluctuations that come from outside, and when they are large they cant be smoothed as in the 1970’s.
As for the internal fluctuations, there is a great role for regulation. But when you do that you are operating on the usual economic tradeoff of risk vs. return. You can get a more stable system but the cost is one where growth might be a little less and profit opportunities smaller. This is particularly true in the financial sector where the opportunity to cart off excess profits and shelter them in personal accounts is never ever passed up. But at the same time the rest of us shouldnt be too impressed with these profit opportunities because they do nothing for most of us. Hence a good public policy tradeoff is to trade some of the profit opportunities in the financial sector for more stability – and doing it through regulation would be a fine idea.
Barry 09.09.09 at 6:17 pm
Yes, particularly because it’s not clear that we’re actually operating in a zone where a fair amount of increased regulation would actually result in lower growth. Jim Henley (highclearing.com) had a blog with a great title, ‘Past Performance Does No Guarantee Past Results’, noting that the growth and productivity figures for this past decade (and possibly some of the late 1990’s) will need to be recomputed, since the finance industry bubble dominated so much.
gappy 09.11.09 at 8:47 pm
Considered as a whole, the performance of developed economics in the era of market liberalism looks considerably less impressive than that of the postwar period of Keynesian social democracy.
This seems more the projection of a word view than a statement grounded in fact. I think that making the terms performance and the actual policies corresponding to market liberalism and keynesian social democracy. To state that keynesian policies are responsible for the future or past (post-WW2) growth seems also very hard to prove.
John Quiggin 09.12.09 at 4:33 am
@gappy; Your middle sentence appears to end prematurely.
As regards the difficulty of proving causation, I agree, but the same applies (or applied while it lasted) to the Great Moderation.
Comments on this entry are closed.