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Saturday, December 6, 2008


Today's Buggy Topic

It's part of the series, started a couple of months ago --- maybe longer, can't recall for sure --- that prof bug has been busy posting about, and familiar to regular visitors here: more specifically, what we can learn from economic theories about the causes of our current system-wide financial meltdown on a global level and the resulting recessionary trends . . . and, by extension therefore, what policy guides they offer the Federal Reserve and our government for dealing with these huge challenges. 

More Specifically, Today's Topic Is About ...

. . . two contrasting theories of recurring financial crises that mark the ups and downs of the business cycle, a regular feature of free-market capitalism ever since the start of the industrial revolution, and maybe earlier too in its predecessors in parts of West Europe.  One is a free-market view of a heterodox sort even in libertarian circles, and with virtually no influence in mainstream economics: in a word, Austrian business cycle theory, especially in the hands of a Nobel Prize-winning economist Friedrich Hayek.  The other is the work of Hyman Minsky, a radical Keynesian who --- besides his academic work as a scholar at Washington University in St. Louis --- had also been a banker for many years.  He, too, has had a limited influence on mainstream economics --- though you now see a fair amount of references to him on the web, amid our current economic turbulence . . . financial and economic. 

The two theories as applied to the current crisis were touched on in passing at the Marginal Revolution by Professor Tyler Cowen of George Mason University, himself a flexible libertarian economist . . . in fact, evidently considered something of a suspect heretic by full-throated libertarians because he doesn't think governments are responsible for any and all market failures in our economy.  That includes his argument that government policies --- such as promoting home-ownership in various ways, not least by Fannie Mae and Freedie Mac as government-backed agencies that buy banks' house-mortgages or at times (as now) offering subsidized mortgages to qualifying house-buyers themselves. 

Enter the Buggy Professor

In the thread that followed Prof Cowen's original comments, the vast majority of the posters --- libertarian students or followers, plus a few dissenters  --- seemed to prof bug to have no idea who Hyman Minsky was and what his theoretical analysis of the business cycle's recurring financial booms-and-busts amounted to.  After all, even in the more moderate New Keynesianism that flourishes these days as the major opponent in macroeconomics of free-market theories --- its most prominent exponent, Gregory Mankiw of Harvard (a Republican who was appointed by President George W. Bush om 2003 to head his Council of Economic Advisers ) --- regards Minsky's work as too radical and too pessimistic about the causes of these financial booms-and-busts and what can be done to curb their worst excesses.

What with this obvious ignorance about Minsky's theoretical work --- which would likely inspire hostility anyway, not just substantively but because it leads to an insistence on careful regulation of financial markets --- prof bug set out a fairly lengthy analysis of Minsky's work.

Minsky's Contributions

They're impressive and very timely, no two ways about it.  Minksy --- who had a career in banking before he became an academic --- drew on some half-forgotten views of the original, more radical Keynes of the mid- and late 1930s.  In particular, if you know his work well and the original disputes in economics about it, Keynes wasn't concerned primarily with the need for fiscal stimuli to deal with the Great Depression --- important and relevant as that policy recommendation was and remains today, though he himself didn't originate the policy guide here.  Rather, the significance of Keynes theoretical work ---before, during, and after his key book, General Theory of Employment, Interest, and Money (1936)--- lies elsewhere. 

Above all, it focused on the the deeper problems in savings and investment markets that, he said, didn't operate with standard-model economic rationality: not always anyway.  Rather, way too of fen, with irrational, emotionally charged psychological swings between excessive optimism and excessive pessimism, and further marked near the top of a boom and the bottom of the bust in the business cycle by marked uncertainties about the future.  The result?  Contrary to classical and neo-classical mainstream work, there was no natural tendency in free-market economies to operate at full employment.  And though active monetary policies might stimulate what Keynes focused on as the determinant of short- and mid-term economic growth over the business cycle: aggregate demand and its components . . . private consumption, private investment, and government spending (minus taxes), plus total exports - total imports.  

---*On Keynes preoccupation with irrational mood swings, animal spirits and not rational calculations that drive financial markets, and the major uncertainties that grip both savers, lenders, and banks at times about the course of the near-future of the economy --- say, two or three years ahead ---- see  prof bug's comments and the link to his much lengthier analysis left at the Marginal Revolution in an earlier buggy post on this site on December 3, 2008.  Keep in mind that Keynes work and that of almost all his followers since recognize fully that the focus on aggregate demand deals with the short- and mid-term output and employment levels (as well as price levels, Keynes himself a pioneer theorist in the 1920s and toward the end of WWII with inflationary tendencies).  Long term economic growth in any market economy depends on supply side influences: the growth and quality of the labor force, capital growth and whether its allocated efficiently, and technological progress broadly understood: increases in knowledge, whether embodied in machines or in better organization, management, and marketing of business firms.

Friedrich Hayek and the Austrian School

The Austrian-school's work, Hayek's especially, was influential in policymaking circles at the start of the Great Depression in the Hoover-administration in the US and elsewhere.  Since then, it has been noticeably eclipsed in influence and not just by Keynesian theory and its variants, but also by mainstream free-market economics as it has developed since WWII --- especially under the influence of Milton Friedman and the University of Chicago economics department . . . the training-ground or home-base of about two dozen Nobel Prize winning economists.  (Interestingly, Hayek --- like other prominent Austrian economists --- fled Austria even before Hitler came to power in 1937, and ended up a British citizen teaching at the London School of Economics, but also in the 1950s at the University of Chicago.) 

 Besides Hayek --- and still very influential in certain economic circles of more fervent libertarian thrust --- there was and is a group of other Austrian and Austrian-influenced economists in the early decades of the 20th century and their followers elsewhere ever since: especially, Ludwig von Mises and Lionel Robbins  . . . the latter a colleague of Hayek at the London School of Economics, in fact the chairman of the economics program who hired Hayek.  Nowadays, their influence is very much confined to a small group of economists even in libertarian free-market circles --- trained or found mostly at George Mason University in Virginia.  Of these, Hayek himself has had more influence in mainstream libertarianism --- not least for his political views about government and individual rights.