Home > Uncategorized > The must read new heterodox paper from Claudio Borio, economist at the Bank for International Settlements

The must read new heterodox paper from Claudio Borio, economist at the Bank for International Settlements

Claudio Borio, economist at the Bank of International Settlements, has written a paper about the Great Financial Crisis: “The financial cycle and macroeconomics: what have we learned”. It’s quite consistent with many of the remarks made on this blog. Read it! Some cutting and pasting:

The Post-Keynesian approach:

Modelling the financial cycle correctly, rather than simply mimicking some of its features superficially, requires recognising fully the fundamental monetary nature of our economies: the financial system does not just allocate, but also generates, purchasing power, and has very much a life of its own.

The Georgist approach:

Arguably, the most parsimonious description of the financial cycle is in terms of credit and property prices … across the seven economies covered in Drehmannet al (2012), the average length of the financial cycle is 16 years

It’s the banks easy credit, stupid!

Financial liberalisation weakens financing constraints, supporting the full selfreinforcing interplay between perceptions of value and risk, risk attitudes and funding conditions. A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms: they raise growth potential and hence the scope for credit and asset price booms while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening…. it is no coincidence that the only significant financial cycle ending in a financial crisis pre-1985 took place in the United Kingdom, following a phase of financial liberalisation in the early 1970s (Competition and Credit Control).

The statistical approach:

Specifically, the most promising leading indicators of financial crises are based on simultaneous positive deviations (or “gaps”) of the ratio of (private sector) credit-to-GDP and asset prices, especially property prices, from historical norms. In addition, there is growing evidence that the cross-border component of credit tends to outgrow the purely domestic one during financial booms, especially those that precede serious financial strains. Importantly, but rarely appreciated, the commonly used monetary statistics do not capture this component

(This post, which argues in favor of household and non-financial company in stead of bank centered monetary statistics is consistent with that idea)

Austrian: the ‘output gap’ has a monetary side, too.

The graph clearly shows that, especially in the 2000s, the credit-adjusted output gaps pointed to output being considerably higher than potential than the other two indicators. By contrast, before the mid-1980s, the various estimates tracked each other quite closely for the United States, which is consistent with much more subdued financial cycles at the time.

Yes, a kind of debt jubilee might sometimes be necessary

The first case, universally recognised as a good example, is how the Nordic countries addressed the balance sheet recessions they confronted in the early 1990s (Borio et al (2010)). The crisis management phase was prompt and short. The authorities stabilised the financial system through public guarantees and, where necessary, central bank liquidity support. Then, almost without any discontinuity, they tackled the crisis resolution phase. With an external crisis constraining the room for manoeuvre for monetary and fiscal policy, they addressed balance sheet repair head-on. They enforced comprehensive loss recognition
(writedowns); they recapitalised institutions subject to tough tests, including though temporary public ownership; they sorted institutions based on viability; they dealt with bad assets, including though disposal; they reduced the excess capacity27 in the financial system and promoted operational efficiencies, so as to lay the basis for sustainable profitability. The recovery was comparatively quick and self-sustained.

No, Borio does not like Fantasy ‘DSGE’ economics

Modelling the financial cycle raises major analytical challenges for prevailing paradigms. It calls for booms that do not just precede but generate subsequent busts, for the explicit treatment of disequilibrium debt and capital stock overhangs during the busts, and for a clear distinction between non-inflationary and sustainable output, ie, a richer notion of potential output – all features outside the mainstream. Moving in this direction requires capturing better the coordination failures that drive financial and business fluctuations. This suggests moving away from model-consistent expectations, thereby allowing for endemic uncertainty and disagreement over the workings of the economy. It suggests incorporating perceptions of risk and attitudes towards risk that vary systematically over the cycle, interacting tightly with the waxing and waning of financing constraints. Above all, it suggests capturing more deeply the monetary nature of our economies, ie, working with economies in which financial intermediaries do not just allocate real resources but generate purchasing power ex nihilo and in which these processes interact with loosely anchored perceptions of value, thereby generating instability. In turn, this in all probability means moving away from equilibrium settings and tackling disequilibrium explicitly. In many respects, all this takes us back to previous economic intellectual traditions that have been progressively abandoned in recent decades.

  1. Raphael Martins
    December 16, 2012 at 6:58 pm

    In the Economists’ coverage of this paper, the correspondant mentions Minsky, Godley and Lavoie, agent-based modelling and Keen as strands of research that are attuned with Borio’s thinking, and that they are the way to go:


  2. Steve
    December 16, 2012 at 9:45 pm

    All reforms to profit making systems are just “can kicking” means to a no longer relevant economic reality changed and made available by technological innovation. If we want to have the best of both profit making systems as well as a more humane system we must up our game to real wisdom and its evolutionary, paradigm changing ideas. Ideas like changing the consumer financial paradigm from loan ONLY to Dividend….(an evolutionary policy reflective of the wisdom of Grace, the free gift, and which is based on the legitimate idea of the “free lunch” of an inheritance, in this case the communally owned inheritance of the technological innovation {not the machinery of such itself}accumulated over the centuries)…
    and loan if desired and creditable. This transformational and yet perfectly practical policy, given the inexorable march of technological innovation and its effects on human effort and even human input/employment is what will enable us to maintain and humanize a profit making economic system. To demand that we keep either no longer adequately functioning profit making policies or equally non functioning employment policies as “solutions”, especially when the changing of the consumer financial paradigm enables both profit and employment to remain a part of the new transformed economy/society….is in the end nothing more than stubborn irrationality.

  3. BC
    December 16, 2012 at 10:00 pm

    We reached the Jubilee point in ’08, which resulted from the cumulative differential growth of debt-money to wages, production, and private GDP reaching an exponential order of magnitude since the early ’80s (the beginning of the Long Wave Downwave), at which point growth of debt-money can no longer occur.

    After four years of federal deficits of 10-15% of private GDP, the US is now at the public debt Jubilee, meaning that growth of public debt to private GDP will be constrained, and any further growth will come at the further contraction of real GDP per capita hereafter, i.e., from higher taxes, reduction in transfers to the private sector, etc.

    Similarly, US non-financial corporate debt to private GDP has reached the Jubilee threshold going back more than half a century. Corporate debt to private GDP can no longer grow hereafter.

    Thus, we have reached the private AND public debt Jubilee. There is no way out apart from (1) debt pay down, (2) debt defaults, (3) debt restructuring and debt and equity holders taking losses, (4) gov’t spending cuts, higher taxes, or a combination, or (5) some combination of (1) to (4).

    In the meantime, real GDP and gov’t spending per capita will not grow.

    Beyond this, the banksters and their rentier caste benefactors have virtual 100% claim on wages, profits, and gov’t receipts in perpetuity from total compounding interest to US total credit market debt owed now equivalent to 100% of private GDP.

    The English-speaking world is laboring under a neo-feudal system of onerous compounding interest claims by the top 0.1-1% on place value land rents resulting from the state’s granting of a monopoly to permit private banks to create debt-money claims against land values in perpetuity, which is then exacerbated by local taxing authorities assessments against the inflationary amortization of land values in perpetuity. The debilitating claims imposed by the banksters, rentier caste, and the state renders labor and land too costly to subsist.

    The bottom 90% working-class masses are subject to onerous payroll taxes against labor (and self-employment) as well as the “rentier tax” consisting of compounding interest claims to labor, production, and gov’t receipts in perpetuity. It should thus be no surprise why the US economy has not created a net new full-time private sector job since the mid-’80s, and not since the late ’70s per capita.

    Similarly, it is not a mystery why nearly half of all American households have been relegated to federal gov’t subsistence income support in the form of Social Security, disability, SSI, food stamps, and public pension payouts.

    The imputed compounding interest costs of the creation of debt-money claims by banksters and the rentier caste and state taxes against inflated land values and labor preclude any further growth of employment, production, and tax receipts.

    The English-speaking world is in desperate need of “land reform” and the repeal of private fractional reserve banking and the perpetual claims against labor, production, and receipts.

  4. Bruce E. Woych
    December 17, 2012 at 12:57 am

    In a somewhat “contemptuous” retrospective:


    The federal budget: Have we a ‘spending orgy’? (Fortune, 1934)
    December 16, 2012: 9:30 AM ET

    Editor’s note: Every Sunday, Fortune publishes a favorite story from our magazine archives. This week, as congressional leaders and the Obama Administration continue with fiscal cliff negotiations, we turn to a feature from December 1934 on the ballooning federal budget during the New Deal era.

  5. December 19, 2012 at 2:51 am

    Gentlemen, Bravo & kudos. I’m flabbergasted by the frank no nonsense material posted above. Steve, especially, my hat’s off to your fealessly concise distillation of the essence. BC, at first /i thought you were over abstracting & slipping downslope in the sleazy mediocracy channel, but I was pleasantly surprised and impressed. Bruce, thanks again for another potently relevant contribution.

  6. Steve
    December 20, 2012 at 7:07 am

    Michael, Thank you. Yes, crafting economic policies is no more difficult to do with one set of ideas as any others. Therefore the refusal to choose the deepest Wisdom as the basis for doing so is really nothing more than either lack of awareness of Wisdom, or a stubborn irrationality that somehow concludes the best and deepest of what we actually are, that is homo sapiens, wise and discerning man, is incorrect or inadequate for the HUMAN system that literally determines whether one survives well or even at all.

    The result of these two road blocks is the orthodox hanging up on some less than universal abstraction and primary intention like profit or employment on the way toward adequate, universal and wise ideas, and thus a claim of policy alignment with universal ideas that is actually misalignment instead. Unfortunately this lack of integration and alignment with our own most defining characteristic is probably modernity’s biggest problem.

  7. Bruce E. Woych
    December 21, 2012 at 2:58 am

    A must read, (partial excerpt & link here):

    “Ironically, in sharp contrast to the Mayan prophesy of “renewal, the real World we live in at the outset of the 21st Century is marked by a formidable economic and social crisis which is impoverishing millions of people, literally destroying people’s lives.

    In the figurative sense, we are in the midst of an unfolding “doomsday scenario” of a complex political, social and economic nature: it’s man made, it’s “Made in America”; it is the consequence of the fracture of the judicial system, the evolving Homeland Security apparatus, the fraudulent deregulation of financial markets, the mismanagement of the real economy.

    These fundamental shifts in America’s institutional and social fabric are coupled with a far-reaching global military agenda and a self-serving US foreign policy. The latter under the helm of Secretary Hillary Clinton points towards potential a breakdown of the channels of international diplomacy.

    War and the Economic Crisis are intimately related. While the global economy is in a state of chaos, marked by the collapse of productive systems, the US and its allies –including NATO and Israel– have embarked upon a military adventure, “a long war” under the disguise of a “global war on terrorism”.

    The Pentagon’s global military design is one of world conquest. The military deployment of US-NATO forces is occurring in several regions of the world simultaneously. Pentagon war games routinely focus on simulating World War III scenarios. This “End of the World” military agenda potentially threatens the future of humanity.

    Media Disinformation

    While World public attention is riveted on the “Mayan apocalypse”, the “Real Crisis” which is affecting humanity is not an object of serious debate. The Pentagon’s “long war” combined with a murky scenario of global impoverishment and economic breakdown is not front page news.

    The corporate media plays a central role in providing legitimacy to a destructive military agenda. The US-NATO weapons arsenal and military deployment in all regions of the World are routinely portrayed as instruments of peace. America’s new generation of tactical nuclear weapons are said to be “harmless to the surrounding civilian population”. Pre-emptive nuclear war, which constitutes a de facto doomsday scenario, is portrayed as a “humanitarian undertaking”.

    Central to an understanding of war is the media campaign which grants it legitimacy in the eyes of public opinion.

    A good versus evil dichotomy prevails.

    The perpetrators of war are presented as the victims.”
    (read entire summary article)
    The Mayan 2012 Prophecy: Orwellian “End of the World” Doomsday is “Made in America”
    By Prof Michel Chossudovsky
    Global Research, December 19, 2012
    Url of this article:


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