Much More than a Must-Read: Paul Krugman: The Case of the Missing Minsky

Must-Read: This isn’t really a “must-read”. It is more of a “must think about”. As readers know by now, I am much less satisfied with Paul Krugman’s declaration that economics today is in more-or-less good shape with respect to the “Bagehot” and the “Keynes” questions–what to do when the economy suffers from manias, panics, and crises; and how thereafter to restore full employment without running unwarranted risks. It is a fact that the Bagehot Rule was not applied fully in 2008-2009. And that many economists were dragging their heels and providing ammunition to those politicians who did not want to apply the Bagehot rule. And it seems to me that there are more analytical holes in the Hicks-Hansen-Wicksell approach to depression economics than Paul recognizes, at least in his more triumphalist moods.

But he is 100% correct in his complaints about continued neglect of the Minsky question…

Paul Krugman: The Case of the Missing Minsky: “Gavyn Davis has a good summary of the recent IMF conference on rethinking macro…

…Mark Thoma has further thoughts… disappointed… decrying:

the arrogance that asserts that we have little to learn about theory or policy from the economists who wrote during and after the Great Depression.

Maybe surprisingly, I’m a bit more upbeat than either. Of course there are economists, and whole departments, that have learned nothing, and remain wholly dominated by mathiness. But it seems to be that economists have done OK on two of the big three questions raised by the economic crisis…. First, a buildup of vulnerability…. Second, the acute phase of crisis, with bank runs or their functional equivalent…. Then a long period of depressed employment and activity, which still isn’t over…. I think of these as the Minsky question… the Bagehot question… and the Keynes question….

On the Keynes question, it’s true that we haven’t had a radical change in thinking, but that’s mainly because the old thinking still works pretty well…. The answer for people asking who would be the new Keynes turns out to be that Keynes is the new Keynes. Or maybe that’s Hicks…. We have had a flowering of empirical work, and… econometric evidence…. Look… at Nakamura/Steinsson… or at… Blanchard…. On the Bagehot question… failure to realize that shadow banking had recreated the risk of bank runs, and failure to appreciate the problems of leverage because there is no room for such problems in representative-agent models. But it wasn’t very hard to fix these problems, or at least apply workable patches… creation of a somewhat messy, inelegant, but usable set of models [was] quite easy. And here too we have seen a flowering of empirical work, e.g. Mian and Sufi….

Where we have not, as far as I can tell, made much progress is the Minsky question. Why did the system become so vulnerable? Was it deregulation (or failure of regulation to keep up with institutional change)? Simple forgetting, as memories of past crises faded? Excessively loose policy? I have views, but I have to admit that there isn’t a lot of either fresh thinking or hard evidence here…. Minsky [is] still mostly missing… because asking how we got here may be less urgent than the question of what we do now… [and] because it’s hard…. behavioral economics doesn’t provide anything like as much guidance as it should. Still, I’m relatively positive in my assessment of the state of macroeconomics. Against mathiness and political ideology, the gods themselves contend in vain, but that’s not a problem with the models.

Mark Thoma: Has the Rethinking of Macroeconomic Policy Been Successful?: “There has been more progress on the theoretical front than I expected…

…particularly in adding financial sector frictions to the NK-DSGE framework and in overcoming the restrictions imposed by the representative agent model. At the same time, there has been less progress than I expected in developing alternatives to the standard models…. My biggest disappointment is how much resistance there has been to the idea that we need to even try to find alternative modeling structures… and the arrogance that asserts that we have little to learn about theory or policy from the economists who wrote during and after the Great Depression.

Gavyn Davies: Has the rethinking of macroeconomic policy been successful?: “The great financial crash of 2008 was expected to lead to a fundamental re-thinking…

…of macro-economics, perhaps leading to a profound shift in the mainstream approach…. That is what happened after the 1929 crash and the Great Depression…. Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks…. What about macro-economic policy? Here major changes have already been implemented, notably in banking regulation, macro-prudential policy and most importantly the use of the central bank balance sheet as an independent instrument of monetary policy. In these areas, policy-makers have acted well in advance of macro-economic researchers, who have been struggling to catch up….

I have… taken the liberty of organising Olivier’s summary and the conference material into the three tables below. Although highly simplified, the tables represent a snapshot of the current ‘state of the art’ in macro policy, at least as seen by today’s mainstream luminaries of the subject…. First, the state of the economy and fiscal policy. An important debate is on whether Lawrence Summers is right to warn about secular stagnation, and if so, why? There is certainly no consensus on this. Most central bankers say that they disagree with Summers (agreeing instead with Ken Rogoff that stagnation will disappear once debt deleveraging is over), but that may be because they do not want to face the policy consequences of him being proved right…. The most important issue, however, is left largely undiscussed…. Whatever economists may think, politicians seem to be far more convinced that a reduction in public debt is essential…. What would happen to the fiscal stance if faced with another recession is unknown…..

The pre-2008 mainstream view of traditional monetary policy, involving inflation targeting, enforced by variations in short rates, seems to have survived largely intact. There is relatively little support for running policy solely according to the Taylor Rule. But there is great uncertainty about how far central bank balance sheets should be reduced, and whether they should retain an independent role…. On regulation, there is widespread agreement that macro-prudential policy weapons are desirable, but little agreement on what they should be, or how they should be deployed….

There has been a decisive shift away from a belief in complete freedom of capital movements…. But the discussion on the need for co-operation between central banks when setting domestic monetary policy–a very live issue ahead of Federal Reserve tightening–was inconclusive….

The much more serious challenge of how policy should adjust in the event of another crisis… were not much addressed…. In the not-very-unlikely event of any of these threats manifesting themselves, there is no obvious ‘play-book’…. As in 2008, policy-makers would have to fend for themselves, but with far fewer options available to them.