RWER issue 54: Korkut Alp Ertürk
Real-World Economics Review, issue 54
You may read the whole paper here:
Heterodox lessons from the Crisis
Korkut Alp Ertürk [University of Utah, USA]]
The crisis had at least one important silver lining. It showed the sheer irrelevance of mainstream macroeconomic theory for understanding what caused the crisis and for policy guidance in its aftermath. For a theory based on the very premise that markets work efficiently at all times the crisis simply could not have happened, and the fact that it did was an anomaly too big to ignore. The few – most notably Paul Krugman among them – who have been trying to take stock seem to have provoked a defense of the beleaguered theory by some of its true believers. Yet, no real mainstream explanation of what has gone wrong has emerged and a few arguments that blame the government or the Fed for the crisis lack conviction. In this lacuna, there has been a hasty retreat to “crude” Keynesianism, yet it is too early to tell how much of a lasting influence that will have either.
The situation is arguably different with heterodox macroeconomists. Not only many among them predicted the crisis, but more importantly their reasons why rested on a coherent theoretical view. So, it is no exaggeration to say the crisis was an intellectual vindication of sorts. But, having said that, it is also true that heterodox theorizing needs to take stock and draw its own lessons from the crisis as well. If the recent discordant slew of articles on whether the crisis was indeed a “Minsky moment” is any indication, heterodox economists do not all seem on the same page on the nature of the crisis and what to do about it – that is, beyond platitudes.
It is in this context that the opportunities for discussion and interaction afforded by conferences such as the one organized by New School students on March 5 of this year is to be especially welcomed. This paper, drawing from a presentation made at this conference, is an attempt to contribute to the heterodox discussion on the crisis, focusing on some of its lessons. Two among these top my list: the crucial role asset price bubbles play in a profit-led macroeconomic system and the importance of reading global imbalances from the capital account side. At the end of the paper it will hopefully be clear how insights from these can enhance our understanding of the predicament the world economy is in today.
Asset Price Inflation
The conceptual distinction between ‘demand-led’ growth and ‘profit-led’ growth goes way back among heterodox economists and thus can be a helpful point of reference for the foregoing discussion. The main point I want to emphasize here is the crucial role asset price bubbles seem to play in how a profit-led regime actually works. Consider the monetary/financial institutional dimension, especially how maturity and liquidity risks are kept under wraps, respectively, in the two regimes. The power central banks have had over commercial banks to rein in or stimulate credit growth, as well as their lender of last resort function, was a defining characteristic of the older ‘demand-led growth’ era. By contrast, in the era of financial liberalization and deregulation that followed, both the overall credit supply and provision of liquidity became market driven and closely tied to changes in asset prices which in turn became especially sensitive to international capital movements.
True, in the earlier era mainstream economists exaggerated the power the monetary authorities had over commercial banks, going to the extreme of assuming that it was in the central bank’s discretion to control the money supply exactly as it desired. This had made it possible for monetarist economists in the 1970s to argue that inflation was solely a monetary phenomenon, caused by too rapid a growth of the money supply. That also meant that it could simply be contained if the central bank curtailed the money supply. Ever since, Post Keynesian economists challenged this monetarist view by correctly arguing that the central bank could not possibly control the money supply the way monetarist economists alleged. While the central bank had considerable discretion in setting the policy interest rate it had next to none over the money supply, which it was argued simply lagged overall bank credit. For the loans commercial banks issued to meet the credit demand from businesses simply returned to the banking system in the form new deposits, a process which the central bank was powerless to check unless it put at risk the very integrity of the payments system. Thus, post Keynesians argued, the influence of the central bank over the economy rested not on its ability to control banks and the money supply as such but instead in its ability to lower or raise the interest rates that impacted businesses’ willingness to borrow. Others thought that the point was overdone, for they recognized that the central bank policy influenced banks’ ability and willingness to make loans as well and emphasized the role of financial innovations. However, as heterodox economists we have long failed to resolve these issues and instead found ourselves mired in a long running debate between, so-called “structuralists” and “accommodationists.”
You may read the whole paper here: