It is indeed a very well-written piece. May I add one wish and one remark. I wish that courses in economic history are seen as a central part of each curriculum in economics again. In Germany, this was lost in the last decade (unfortunately) — even if one can be sceptical if it would have helped to avoid the situation.
The remark: there is some probability that the next generation will be a bit more risk-averse, see the nice piece here
However, this comes at the costs of high uneployment and a long and deep depression.
Excellent piece and a welcome counterpoint to the foolish puff piece the Times of London.
a ‘partial and blinkered reading of that literature’-exactly.
And “the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.”
Here one of the central tenets of modern economics, the Efficient Market Hypothesis, undoubtedly played a major role. If the market price is always right and asset prices always ‘valued’ correctly by the market then bubbles are impossible.
The descent on the ‘quants’ on Wall St. is also important, mistaking as they did, their models for reality. The collapse of LTCM should have been a warning sign. Instead the Nobel laureates who engineered its catastrophic strategy continued to have major influence.
Practitioners of financial economics who use the work of Samuelson, Markowitz, Scholes, Merton, Fama and Fischer, etc. are usually ignorant of the intellectual, and ideological, origins of these theories.
Central banks too were captured by libertarian ideology:
“The Federal Reserve has been hobbled by at least two major shortcomings that were primarily responsible for the current and several previous credit crises. Its failure to spot the importance of changing financial markets and its commitment to laisser faire economics were big mistakes and justify a fundamental overhaul of the Fed.”- Henry Kaufman, Financial Times, April 27 09
Physicists do not disagree like this about gravity or relativity. So maybe Richard Tol is right and economics is more akin to religion (with high priests and heretics) than it is to science.
Bravo Ulrich! I remarked on this blog before – if you had to choose either monetary economics or monetary history as the core of a training course for financial regulators, I would choose history every time.
@ Calan,
It’s absolutely hilarious that Kaufman thinks that a very un-libertarian institution – the Fed – can be swayed by libertarian ideology. Either the Fed has slowly withdrawn itself from economic, or the word “libertarian” has been dramatically debased.
@ Calan 2,
Perhaps an evolutionary analogy might help. Just like the Darwinians and the Lemarckians can’t both be correct, neither can the Keynesians, Monetarists, Austrians, Rational Expectationists….
Matt:
While its true that the existence of central banks is incompatible with libertarian economics, nevertheless Alan Greenspan, was chairman of the Fed for close to 20 years. So perhaps Greenspan’s libertarian ideology influenced Fed policy and this was what Kaufman had in mind.
Greenspan admitted that his ideology was faulty. Clearly ideology is much more a factor in economics than it is in physical science.
Greenspan gave up his libertarian ideology long ago when he joined the establishment. Who would have thought that this central banker (or should that be “central planner”?) was once the author of lines like:
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.”
I might add, that this “flaw” that was just “discovered” by Greenspan smells like a bit of a ploy to divert the blame from where it really lays – on Greenspan himself. Ever notice that the maestro was always quick to take credit for the wonderful economy he had created, but is now quick to claim that the crisis is somehow everybody else’s fault but his?
If any ideology is faulty, it is the one that claims central planners can accurately set prices and manage our monetary affairs.
and Matt: its possible that the Lamarckians may have a point,–and do not contradict Darwinism.
-the concept of Lamarckian inheritance has made a comeback in recent years, as scientists learn more about epigenetics.- MIT, Technology Review
(And such findings are consilient with the work of James Heckman) http://www.technologyreview.com/biomedicine/22061/
Mat
Thanks for that reference to http://irishliberty.wordpress.com
Useful site and needs more participation. The eay way if anyone was really interested, to find which of the various schools was more accurate would be to assess which commentators were more correct in their predictions and to which school they belonged. But the problem with that would be that when the next bubble is being blown the establishment tends to ignore the results. The list of pretexts is long and known to most of us. Even if most of the people were aware of the correct destination of the failed policy of inflation, pumped up by fractional reserve lending, they will still be swayed by emotion. The choice of slowing the economy for the sake of long term growth at the expense of a decade of bubble may not be popular and demogogues are still cheap to buy.
The problem therefore should be addressed by dealing with the bankers themselves: No joint stock incorporation. Full liability partnerships. For all but credit unions.
Only when managers are owners will this theft which so impacts on the rest of the economy stop!
Well written yes. But very much with an axe to grind. And the bankers and regulators, because of their professional positions, are in no position to reply.
I contributed data to the 1615 report. The limitations were widely appreciated. It went on to heavily influence Basel. And I remember a certain day in 2004 at Lehman when the FSA allowed LB increase its leverage.
So the roots of the crisis are many. It does a disservice to overly simplify and slant the intepretation.
For sure, there will be no recovery until banks can pull out of today’s disaster. A better litmus test of the use of economic analysis is how it can help us do that, right now.
Matt:
The Efficient Market Hypothesis is the product of liberal economic ideology. The notion that the market always prices assets accurately denies the possibility of bubbles. That Greenspan and his acolytes at the Fed were imbued with such notions contributed hugely to the making of the current debacle.
True believers excommunicate Greenspan from the libertarian church because he was a central banker.
That such a free marketeer ideologue as Greenspan can be regarded as a heretic to the one, true, purist, Austrian faith makes my point that economics is more akin to religion than science and that it is riddled with ideology.
If Greenspan really believed in market pricing, why would he have accepted the role of attempting to fix interest rates (the price of money)? Either he didn’t really believe in the market, or he took the job for political/personal reasons.
Graham you’ve convinced me. Greenspan is clearly an enemy of free market capitalism, maybe even a socialist. The fact that he once played jazz professionally should have been a warning sign. How could I have missed it! Thanks to you, and to Matt too, for removing my blinkers. I herby recant.
meh, fortunately I’m no rational expectationer or EMHer. Quite frankly business cycles are not psychological nor ideological phenomena, but rather praxeological ones (driven by action). Perhaps it was ignorence or malevolence on Greenspan’s part that drove him to do what he did, who knows.
Anyways, as far as the religious comparison goes, you fortunately haven’t fallen into the trap of pushing one school as the “scientific” method, and labelling all others “religions” (instead calling them all religions, which is slightly better).
Excellent article by Barry Eichengreen,Well done to K O rourke for finding it,At least someone is asking the big questions!
Excellent article alright, I wonder what the economists on this blog think of:
1. The assertion that lax monetary policy (the Fed) caused the crisis?
2. The role of the price of oil in causing the crisis and as a potential stimulus that will aid recovery?
Tony Allright’s article on the oil subject is interesting:-
3. The thesis in George Soros’ book (and also of Warren Buffet) that the efficient market hypothesis does not hold?
‘The Crash of 2008 and What it Means: The New Paradigm of Financial Markets’ is an excellent contribution. Soros is himself proof that the theory does not hold, also numerous bubbles and LTCM. I recommend all economists to examine Soros and reflexivity. The proof is in his billions.
19 replies on “Barry Eichengreen on economics”
It is indeed a very well-written piece. May I add one wish and one remark. I wish that courses in economic history are seen as a central part of each curriculum in economics again. In Germany, this was lost in the last decade (unfortunately) — even if one can be sceptical if it would have helped to avoid the situation.
The remark: there is some probability that the next generation will be a bit more risk-averse, see the nice piece here
http://www.econ.berkeley.edu/~ulrike/Papers/DepressionBabys_16.pdf
However, this comes at the costs of high uneployment and a long and deep depression.
Excellent piece and a welcome counterpoint to the foolish puff piece the Times of London.
a ‘partial and blinkered reading of that literature’-exactly.
And “the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.”
Here one of the central tenets of modern economics, the Efficient Market Hypothesis, undoubtedly played a major role. If the market price is always right and asset prices always ‘valued’ correctly by the market then bubbles are impossible.
The descent on the ‘quants’ on Wall St. is also important, mistaking as they did, their models for reality. The collapse of LTCM should have been a warning sign. Instead the Nobel laureates who engineered its catastrophic strategy continued to have major influence.
Practitioners of financial economics who use the work of Samuelson, Markowitz, Scholes, Merton, Fama and Fischer, etc. are usually ignorant of the intellectual, and ideological, origins of these theories.
Central banks too were captured by libertarian ideology:
“The Federal Reserve has been hobbled by at least two major shortcomings that were primarily responsible for the current and several previous credit crises. Its failure to spot the importance of changing financial markets and its commitment to laisser faire economics were big mistakes and justify a fundamental overhaul of the Fed.”- Henry Kaufman, Financial Times, April 27 09
Cherish the heretics!
-Robert M. Solow of Massachusetts Institute of Technology (Nobel 1987) says the only thing wrong with the Administration’s fiscal stimulus is that it’s too small. In contrast, Edward C. Prescott of Arizona State University (Nobel 2004) argued that Obama’s stimulus measures “are depressing the economy.” –
http://www.businessweek.com/magazine/content/09_12/b4124018582044.htm?chan=top+news_economics+subindex+page_economics
Physicists do not disagree like this about gravity or relativity. So maybe Richard Tol is right and economics is more akin to religion (with high priests and heretics) than it is to science.
Bravo Ulrich! I remarked on this blog before – if you had to choose either monetary economics or monetary history as the core of a training course for financial regulators, I would choose history every time.
@ Calan,
It’s absolutely hilarious that Kaufman thinks that a very un-libertarian institution – the Fed – can be swayed by libertarian ideology. Either the Fed has slowly withdrawn itself from economic, or the word “libertarian” has been dramatically debased.
@ Calan 2,
Perhaps an evolutionary analogy might help. Just like the Darwinians and the Lemarckians can’t both be correct, neither can the Keynesians, Monetarists, Austrians, Rational Expectationists….
Matt:
While its true that the existence of central banks is incompatible with libertarian economics, nevertheless Alan Greenspan, was chairman of the Fed for close to 20 years. So perhaps Greenspan’s libertarian ideology influenced Fed policy and this was what Kaufman had in mind.
Greenspan admitted that his ideology was faulty. Clearly ideology is much more a factor in economics than it is in physical science.
-When asked if his ideology pushed him to make bad decisions, Greenspan said he found a “flaw” in his governing ideology that has led him to re-examine his thinking.-
http://www.npr.org/templates/story/story.php?storyId=96070766
Calan,
Greenspan gave up his libertarian ideology long ago when he joined the establishment. Who would have thought that this central banker (or should that be “central planner”?) was once the author of lines like:
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.”
I might add, that this “flaw” that was just “discovered” by Greenspan smells like a bit of a ploy to divert the blame from where it really lays – on Greenspan himself. Ever notice that the maestro was always quick to take credit for the wonderful economy he had created, but is now quick to claim that the crisis is somehow everybody else’s fault but his?
If any ideology is faulty, it is the one that claims central planners can accurately set prices and manage our monetary affairs.
and Matt: its possible that the Lamarckians may have a point,–and do not contradict Darwinism.
-the concept of Lamarckian inheritance has made a comeback in recent years, as scientists learn more about epigenetics.- MIT, Technology Review
(And such findings are consilient with the work of James Heckman)
http://www.technologyreview.com/biomedicine/22061/
Mat
Thanks for that reference to http://irishliberty.wordpress.com
Useful site and needs more participation. The eay way if anyone was really interested, to find which of the various schools was more accurate would be to assess which commentators were more correct in their predictions and to which school they belonged. But the problem with that would be that when the next bubble is being blown the establishment tends to ignore the results. The list of pretexts is long and known to most of us. Even if most of the people were aware of the correct destination of the failed policy of inflation, pumped up by fractional reserve lending, they will still be swayed by emotion. The choice of slowing the economy for the sake of long term growth at the expense of a decade of bubble may not be popular and demogogues are still cheap to buy.
The problem therefore should be addressed by dealing with the bankers themselves: No joint stock incorporation. Full liability partnerships. For all but credit unions.
Only when managers are owners will this theft which so impacts on the rest of the economy stop!
Remember Iceland
Remember OPM (Other people’s money)
Well written yes. But very much with an axe to grind. And the bankers and regulators, because of their professional positions, are in no position to reply.
I contributed data to the 1615 report. The limitations were widely appreciated. It went on to heavily influence Basel. And I remember a certain day in 2004 at Lehman when the FSA allowed LB increase its leverage.
So the roots of the crisis are many. It does a disservice to overly simplify and slant the intepretation.
For sure, there will be no recovery until banks can pull out of today’s disaster. A better litmus test of the use of economic analysis is how it can help us do that, right now.
Matt:
The Efficient Market Hypothesis is the product of liberal economic ideology. The notion that the market always prices assets accurately denies the possibility of bubbles. That Greenspan and his acolytes at the Fed were imbued with such notions contributed hugely to the making of the current debacle.
True believers excommunicate Greenspan from the libertarian church because he was a central banker.
That such a free marketeer ideologue as Greenspan can be regarded as a heretic to the one, true, purist, Austrian faith makes my point that economics is more akin to religion than science and that it is riddled with ideology.
If Greenspan really believed in market pricing, why would he have accepted the role of attempting to fix interest rates (the price of money)? Either he didn’t really believe in the market, or he took the job for political/personal reasons.
Graham you’ve convinced me. Greenspan is clearly an enemy of free market capitalism, maybe even a socialist. The fact that he once played jazz professionally should have been a warning sign. How could I have missed it! Thanks to you, and to Matt too, for removing my blinkers. I herby recant.
for a critical reaction, see http://econlog.econlib.org/archives/2009/04/barry_eichengre.html#more
Calan,
meh, fortunately I’m no rational expectationer or EMHer. Quite frankly business cycles are not psychological nor ideological phenomena, but rather praxeological ones (driven by action). Perhaps it was ignorence or malevolence on Greenspan’s part that drove him to do what he did, who knows.
Anyways, as far as the religious comparison goes, you fortunately haven’t fallen into the trap of pushing one school as the “scientific” method, and labelling all others “religions” (instead calling them all religions, which is slightly better).
Excellent article by Barry Eichengreen,Well done to K O rourke for finding it,At least someone is asking the big questions!
Excellent article alright, I wonder what the economists on this blog think of:
1. The assertion that lax monetary policy (the Fed) caused the crisis?
2. The role of the price of oil in causing the crisis and as a potential stimulus that will aid recovery?
Tony Allright’s article on the oil subject is interesting:-
http://www.tallrite.com/weblog/archives/october08.htm#Oil:_The_Cause_of_and_Solution_to_the_Financial_Turmoil
Sorry, one other point:
3. The thesis in George Soros’ book (and also of Warren Buffet) that the efficient market hypothesis does not hold?
‘The Crash of 2008 and What it Means: The New Paradigm of Financial Markets’ is an excellent contribution. Soros is himself proof that the theory does not hold, also numerous bubbles and LTCM. I recommend all economists to examine Soros and reflexivity. The proof is in his billions.