Archive

Financial stability, or the lack thereof.

The title of the conference, “Paradigm Lost,” is an obvious combination of two references.

The ongoing eurozone crisis has prompted many to argue that monetary union withoutfiscal union was bound to fail.

Leading thinkers from outside the developed countries look to the future, spotlighting the pitfalls and opportunities thatawait us.

Albeit the majority of the profession either ignores Minskyís Financial Instability Hypothesis (FIH) or considers it plainly wrong, at least since the mid-80’s a few influential economists —who have certainly not embraced any unorthodoxcredo —have grown more receptive to this idea and eager to incorporate it in their models, even if diluted and sometimes disguised in order to make it more palatable to the conventional “representative” macroeconomist

I am supposed to speak about Complexity Economics and the issues this theoretical approach is able to illuminate. Defined as such, it appears as if I should discuss methodology and I am reminded of Paul Krugman’s quote: “It is said that those who can, do, while those who cannot, discuss methodology”. So, having a discussion centered on methodology may give the impression that the panelists in this session are unable to make scientific progress.

Elephant seals have got too big for their beaches. A large specimen might weigh over 8000 lbs (3700 kg).Their size has a simple evolutionary explanation. Large males fight for the right to mate with a whole beach full of females. For elephant seals it is, quite literally, winner-takes-all. And the key to winning is simple – size.

We have grown accustomed to regulating financial markets based on imagined, not real markets. Real markets are shaped by and co-evolve with institutional arrangements within two fundamental constraints: Imperfect knowledge and the threat of illiquidity.

The financial sector can support growth but it can also cause crisis. The present crisis has exposedgaps in economists’ understanding of this dual potential.

In the seemingly never-ending aftermath to the economic crisis that began in 2007, there is little disagreement that financial markets are characterized by instability rather than stability.

Many feel that due to its size and scale the financial system has become a burden on society rather than a servant to it. What are the key elements of a productive financial sector?

Complexity economics represents a different vision of the economic process and has the capacity to illuminate different systems of behavior.

Read how did the second day of the Berlin conference go

Mark Thoma has picked up on a significant aspect of this year’s INET annual conference

The Institute for New Economic Thinking (INET) today announced a significant infusion of funding that over the coming years will make the organization self-sustaining and enable INET to dramatically expand its global reach, scale, and scope.

I think I am on the track of what ‘New Economics’ is, and one could roughly sum up two days of presentations in two diagrams:

Lunch was just interrupted Bill Janeway standing up to announce that this morning he decided to give $25m to INET and the board will fund-raise this up to $100m over ten years, but then George Soros added $50m in unconditional funding for INET.

Taking a long‐run view from economic history, I make three points about instability in financial markets. First, I argue that economic historians have a relatively good understanding of the proximate causes of financial crises.

“Natural rate theory” has dominated interpretations of economic trends and policy prescriptions over many decades. European-type welfare state institution were claimed to cause a compressed wage distribution that distorts otherwise well functioning labor markets.

Many models of economic growth exclude materials from the production function. Growing environmental pressures and resource prices suggest that this may be increasingly inappropriate.

The topic of this session of the INET conference is a question: does the effectiveness of fiscal policy in stabilizing an economy depend on the underlying economic context in which the policy is implemented?

The present paradox, as ecological economist Bill Rees is fond of putting it, is simple yet profoundly troubling: “The ecologically necessary is politically infeasible, but the politically feasible is ecologically irrelevant.”

The effectiveness of fiscal stimulus in promoting economic recovery appears to depend upon many factors.

What creates instability in financial markets? How does the weight of debt, the structure of expectations, or radical uncertainty contribute to instability?

Inequality has been growing and destabilizing confidence in many countries in recent years.

Evidence of climate change is widely accepted by scientists.

Three major crises are confronting the world. The first is the increasing and uneven burden of humans on the biosphere, and the observation that we have already surpassed the ‘safe operating space’ for humanity with respect to three planetary boundaries: climate change, the nitrogen cycle and biodiversity loss.

The path to better understanding the economy requires treating the economy as the complex system that it really is. We need more realistic behavioral models, but even more important, we need to capture the most important components of the economy and their most important interactions, and make realistic models of institutions.

In 1803 Louis Poinsot, a French physicist, wrote a book of great success, Elements de Statique, which was destined to have practical and social influences unimaginable to the same author.

In the last few years the impact of income distribution on macroeconomic dynamics has received growing academic attention.

How can we distribute growth globally when the developed world needs growth to emerge from debt overhangs and inequality between nations is still quite formidable?

Long periods of unequal incomes spur borrowing from the rich, increasing the risk of major economic crises

Higher income inequality in developed countries is associated with higher domestic and foreign indebtedness

Does greater inequality produce more fragile economic dynamics? Does concentration of wealth and income make societies more prone to crisis? If so, why?

Soros’s remarks about the 2008 crash

We analyze shareholders’ incentives to change the leverage of a firm that has already borrowed substantially. As a result of debt overhang, shareholders have incentives to resist reductions in leverage that make the remaining debt safer.

Budget cuts can be dangerous. Inspired by the wrenching experience in Greece, increasing attention is now being paid to the fact that austerity may fail to reduce the government deficit if the economy declines in response, as is likely in a liquidity trap (Delong and Summers 2012).

A country that produces goods of high quality at a competitive price is likely to be rewarded for its ingenuity with a trade surplus. Small countries often achieve great development success through export-led growth. At the same time, the entire economic system must be balanced.

These are truly testing times. The world economic order – capitalism – is being called into question following the Lehman crisis. The world’s best form of societal organization – democracy – is being challenged by the economic success of autocratic countries such as China and Singapore.

When the very fabric of society is threatened by prolonged austerity or a financial sector collapse, a deliberate re-structuring of debt may be necessary to restore the hopes of renewed prosperity.

After an era of vigorous expansion a downturn can reveal a large stock of debt relative to the economy’s capacity to service it.

What has been learned now that the Euro zone’s fault lines have been revealed? Where are Europe and the Euro zone today?

INET’s Berlin Conference, “Paradigm Lost: Rethinking Economics and Politics,” opened yesterday and continues to receive enthusiastic coverage from both local and international press.

Just as the agricultural share of employment has fallen from 40% in the 1920s to less than 2% of the workforce in Europe today, manufacturing’s share of employment will fall to less than 5% of employment.

While yesterday presented a number of frontrunning scientists discussing current economics and state of the economy in general, academic terms, today starts with ECB executive board member Asmussen.

Behind all the technical language and the common theme of bashing bankers, there remains the Great Divide between Germans and the rest.

Mark Thoma offers a thorough, nuanced take on Roman Frydman’s theory of Imperfect Knowledge Economics (IKE) and George Soros’s ideas on the inability of people to predict the outcomes of financial and social change, which Soros calls “fallibility” and “reflexivity.”

On my way back home from the Brandenburger Tor, I recalled that I already have been there, it must have been in 1988.

A suprisingly large number of talks refer to the issue of human decision making.

The Institute joined the Centre for International Governance Innovation, and the Mercator Research Institute on Global Commons and Climate Change in hosting its third-annual plenary conference in Berlin from April 12-15, 2012.

In modern economies, individuals and companies engage in innovative activities, discovering new ways to use existing physical and human capital, and new technologies in which to invest. The institutional and broader social context within which these activities take place also changes in novel ways.

With my remarks today on financial markets and the financial crisis, I do not make any claims to originality. Rather, they are intended as a reminder of certain circumstances that are already familiar to us, in one form or another.

The global economy is in turmoil. Societies are unstable and not anchored by faith in the system or social order.

The economics profession stands on the fragile foundation of presuppositions adopted by professional agreement rather than as a result of empirical observation.

The human brain relies on three devices for its decisions: emotion controls; addictive learning; and intellectual processing. Understanding the conditions under which the three devices are engaged is essential for conscious decision-making.

George Soros, Axel Leijonhufvud and Perry Mehrling in Berlin, Germany (2012).

Read how did the day of the Berlin conference go

A new interdisciplinary research center to explore and challenge conventional economic thinking has been created by the Oxford Martin School in collaboration with the Institute for New Economic Thinking (INET).

Dinner has already rolled around on what has been a quick day.

Just wanted to let you all know that amongst the distinguished, distinguishable and disturbing people at the INET conference we have inserted ourselves in the middle to do some interviews, attend talks and blog about what is going on.

In science, empirical disciplines such as physics, chemistry, history, and parts of sociology and political science, reason from facts.

FT Alphaville has picked up on my friend James Sweeney’s latest, and since James cites the latest writings by other friends Zoltan Pozsar, Manmohan Singh, as well as my own most recent, the piece reads like a discussant’s comments on a shadow banking symposium.

Having just started Findlay and O’Rourke’s mammoth history of world trade in the second millenia, I have been struck by a strange incongruity

Last week the central banks of China and Australia announced the creation of a $31bn currency swap line

Registration is now open for YSI Commons, at INET’s Plenary Conference, Berlin April 12-15.

Yesterday the Chancellor of the Exchequer (or UK ‘finance minister’) gave his annual budget speech where UK fiscal policy is set for the coming years.

We reserved 25 slots, but we got 563 applications. Something had to be done.

Entangling alliances or entangling leagues are nothing to the entanglements of cash owing—Keynes

The G20 must address the problem of sovereign debt.

Is China’s manufacturing sector in decline?

In his notorious “How Did Economists Get It So Wrong” NYT article in 2009, Paul Krugman relied on the freshwater/saltwater distinction to explain that the economists’ inability to predict and solve the current economics crisis was due to the fact that MIT/Harvard economics lost their long dispute against their Chicagoan counterparts.

Discussion of the results of the ECB’s LTRO2 has revolved around the question of hoarding, specifically whether banks are using the newly-created reserves to fund new lending.

Fundamentally, the ECB is trying to keep the ongoing sovereign debt crisis from turning into a full-fledged bank credit crisis.

Judy Klein is Professor of Economics at Mary Baldwin College in Virginia. She is the author of Statistical Visions in Time: A History of Time Series Analysis 1662-1938, (Cambridge 1997) and co-editor of The Age of Economic Measurement (Duke 2001), and co-author of The Strange Career of Cold War Rationality (in preparation)

In Europe and the United States, political and economic breakdowns have become untenable.

Perry and I extend our apologies for the unplanned hiatus. By way of breaking radio silence, it seems appropriate to check in on our two favorite banks.

At least since Joseph Schumpeter we know that credit is good for economic growth. At least since 2007 we know that too much credit foreshadows financial turmoil.

Inequality did not increase during the early stages of economic development in Japan and the East Asian Tigers. But in India and China it did. Why is that?

I am writing from my notes. The event I want to report took place some two months ago, I have since been preoccupied, then occupied, and now increasingly overwhelmed.

Over the past two hundred years, poor countries have become faster at adopting the technologies of rich countries. So why is it, the economist asks, that poor countries have remained poor, by and large?

A new angle on the link between property rights and economic growth

Strong enforcement of property rights is good for economic growth, says the conventional wisdom. The link may not be as clear cut, says Suresh Naidu

A money view of SDRs

Carmen Reinhart and Kenneth Rogoff tell the history of financial crisis as a tale of excessive public debt. But what more commonly drives financial instability, says Moritz Schularick, is excessive private debt.

From a money view perspective, the central issue is settlement of TARGET balances between national central banks within the Eurozone, and the key is to understand TARGET balances as a kind of interbank correspondent balance.

What can be done to repair economics so economists can play a productive role in helping society?

We are pleased to announce the program of INET’s annual plenary conference in Berlin.

The current account still matters, but other things do too, and maybe more. In light of recent focus on gross flows, here and elsewhere, I want to argue for the language of the balance of payments.

In recent years, an increasingly significant part of the history of economics has modeled itself after the methodologies developed by Science and Technology Studies (STS) scholars.

The title is the same as that of Maury Obstfeld’s Ely Lecture, delivered Jan 6 at the AEA meetings in Chicago. Yours truly was at the meetings mainly to deliver a paper on “Three Principles for Market-Based Credit Regulation”, about which more in a later post. And for most of the rest of the time I was locked in a hotel room interviewing candidates for an assistant professor slot at Barnard College (which gave me a good overview of the current state of macroeconomics, again fodder for a later post).

The Institute for New Economic Thinking will host its third annual plenary conference in Berlin fromApril 12 to 14, 2012.

Are there more poor people on our planet today than there were last year? Many economists would approach this question as mainly a technical problem, a matter of counting.