De-Long’s Attempt to Appropriate Financial Instability Theory

Last week there was an interesting spat between Brad-de-Long and Steve Keen.  DeLong had published a post stating that he a fellow group of New Keynsians/Neo-classicals were:

those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.

Keen replied with some indignation that this group were precisely those who did not predict the Global Financial Crisis, so why not mention some of those who do?  Delong in comments described Keen as a ‘splitter’!

Though badly tempered the post was seen by many commentators as an example revisionist historicist.  So that rather than the mainstream getting wrong it had got it right, they were the true heirs of Minksy Kindleberger etc. Oh and by the way they really had seen it coming.

Today Brad Delong together with his colleague  the great economic historian Barry Eichengreen has republished on Credit Writedowns a peice from Vox which confirms this view.  They repeat an exchange

when Martin Wolf, dean of the British financial journalists, challenged then former-US Treasury Secretary Lawrence Summers in 2011 to deny that economists had proven themselves useless in the 2008-9 financial crisis, Summers’s response was that, to the contrary, there was a useful economics. But what was useful for understanding financial crises was to be found not in the academic mainstream of mathematical models festooned with Greek symbols and complex abstract relationships but in the work of the pioneering 19th century financial journalist Walter Bagehot, the 20th-century bubble theorist Hyman Minsky, and “perhaps more still in Kindleberger” Summers was right.

Kindleberger observed

markets can continue to get it wrong for a very, very long time. He girded his position by elaborating and applying the work of Minsky, who had argued that markets pass through cycles characterised first by self-reinforcing boom, next by crash, then by panic, and finally by revulsion and depression. Kindleberger documented the ability of what is now sometimes referred to as the Minsky-Kindleberger framework to explain the behaviour of markets in the late 1920s and early 1930s – behaviour about which economists otherwise might have arguably had little of relevance or value to say.

So are the likes of Summers, DeLong etc. now contrite by embracing the disequilbrium approach of Minksy-Kindleberger?  No because the lessons that Delong takes from Kindleberger are solely behavioural ones once assets become overpriced and distressed selling sets in, panic, contagion and the lack of a lender and consumer of last resort.

Kindleberger’s key theoretical contributions related to these behavioural issues at certain stages of the credit cycle.  But what the article, and DeLongs whole attempt to claim Minsky et al. as intellectual forebears misses is the basis of that credit cycle in the first instance – endogenous money issued overexhuberently on the basis of speculative prices, what was called in the early 19th C ‘Fictitious Capital’ (see Perelmens excellent pamphlet on its history).  The basis of credit cycle theory is endogenous money  – and a line of thinkers each buildings on the last Tooke, Macloud, Marx, Tassuig, Hawtry, Fisher, Minsky, Kindleberger and Keen have each sought to explain credit and asset price cycles and subsequent depression and develeraging through this monetary cycle.

Delong therefore cannot pull off a historigraphical sleight of hand by trying to appropriate the results of Kindleberger without adopting the theoretical foundations that led him to his conclusions.  Those foundations would require abandonment of the New Keynesian non-monetary, non-credit, equilibrium assumptions of the failed neo-classical paradigm.

13 thoughts on “De-Long’s Attempt to Appropriate Financial Instability Theory

  1. As I have pointed out, the only comprehensible criticisms Steven Keen makes of my column–the only reasons for his claim that in order for economics to make progress I must first die–are (a) that he does not like the fact that my list of nine includes Olivier Blanchard and Larry Summers, and does not include Steven Keen, and (b) “Kindleberger bad! Minsky good!”

    Well, the long exclusive list surely does include Steven Keen. This is a short list, a non-exclusive list–that’s the work that the “economists like” and the “and their peers” phrases are doing in my column.

    Well, Olivier and Larry (along with Barry Eichengreen and Charlie Kindleberger) taught me this stuff: Olivier was especially strong in directing me toward thinking about issues of financial fragility and leverage, and Larry was especially strong in directing me toward thinking about behavioral finance, extrapolative expectations, and “noise traders”. They belong on this list.

    Olivier, Larry, and Christy (not Paul) Romer have also been at the forefront of policymakers pushing for a more-effective less-insane policy response to the downturn: they belong on the list.

    I cannot imagine anybody denying that Paul Krugman, Gary Gorton, Raghuram Rajan, and Barry Eichengreen issued powerful and prescient warnings in the 2000s about leverage, financial instability, and its real consequences. They belong on this list.

    Randall Wray complains that Carmen Reinhart and Ken Rogoff don’t belong on this list. I don’t get that. They have been thinking about the right issues. Randall does not like their conclusions–I don’t agree with (most of) their conclusions either, but they are smart people doing their best and making strong arguments.

    My list is a list of people I consider to be very smart who have taught me important things and whom I listen to carefully. If Keen (or Lainton) wants to get on my list, they need to teach me something. Claiming that what I write is “utter drivel”–without making any substantive complaints at all–stating that I must die for economics to progress, or making empty rhetorical claims that we must “abandon the New Keynesian non-monetary, non-credit, equilibrium assumptions of the failed neoclassical paradigm” simply does not cut it.

    • The lady protests too much

      I didnt call for you to die, nor did I complain about who was on your list – that was reportage.

      My point was you cant have a Minksy-Kindleberger theory without a proper treatment of debt and money – the approach that lead them to their findings. That isnt empty rhetoric, rather it had an empty risposte.

  2. I think the only constructive thing for me to do is to quote Martin Wolf and Lawrence Summers:

    Martin Wolf: “I’d like to start in the following way. Obviously most of the people here – and I’m certainly one of them – think that what happened in the crisis indicates that at least there are some very big questions if not some pretty obvious symptoms of a profound failure in modern economics and in the way we think about how the economic system works, both in macroeconomics and in finance. So what I would like to start with, Larry, is how far you share that perspective. How far you feel that what has happened in the last few years, what we’re left with, just simply suggests that economists didn’t understand what was going on.”

    Lawrence Summers: “There’s things economists didn’t know, there’s things economists were wrong about, and there’s things where some economists were right. When I was in the government, I got a lot of papers in the mail. To the first approximation I attempted to read all the ones that used the words “leverage,” “liquidity,” “deflation” or “depression,” and I attempted to read none of the ones that used the words “neoclassical,” “choice theoretic,” “real business cycle” or “optimizing model of.” There were more in the second category than there were in the first, but there were a reasonable number in the first, and they told you a lot. There is a lot in Bagehot that is about the crisis we just went through. There’s more in Minsky, and perhaps more still in Kindleberger.

    “There is enormous amounts that is essentially distracting, confusing and problem-denying in the stuff that is the substance of the first year course in most PhD programs. So I think economics knows a fair amount. I think economics has forgotten a fair amount that’s relevant, and it has been distracted by an enormous amount. I don’t think the general macroeconomics kept up with the revolution in finance as it was realized that asset prices show large volatility that don’t reflect anything about fundamentals. I don’t think contemporary macroeconomics adjusted or adapted to changes in the patterns of financial intermediation and the ways in which that took place.

    “I think people who were practical, understood concepts of liquidity finding its way into price inflation or into asset price inflation and being problematic either way. But I think those concepts of liquidity into asset price inflation were at the very edge of, in many cases, not even at the edge, of contemporary macroeconomics to the great detriment of contemporary macroeconomics.

    “On the other hand, it’s common in a moment like this to go into a general bash on economics, and everyone who hates economics because they don’t like markets in any context or because they don’t do math, and so if you do a subject with math, you just have a bias towards believing that math is useless. Everyone who doesn’t like economics has piled on at this moment to regard this crisis as a repudiation of economics, and I don’t think that’s right. I think the wisdom that’s in the Bagehot, Minsky, Kindleberger or Eichengreen, Akerlof, Shiller, many, many others, actually runs way ahead of those who mostly bring negative attitude about economics, and I think that we make a serious mistake if we threw the baby out with the bathwater here…”

  3. And once again:

    Lawrence Summers: “I was heavily influenced as I did whatever it was I did, by the basic Keynesian IS/LM framework as augmented to take account of the liquidity trap. I was heavily influenced by a variety of the kinds of writings of Jim Tobin about financial intermediation, in particular about debt deflation, the prospect of instability. I was substantially influenced by work on bank runs, multiple equilibria and the theory of bank runs that is more recent. I was influenced by a good deal of what modern finance understands about bankruptcy and restructuring as we thought about treating the banks and as we thought about treating the automobile companies.

    “I would have to say that the vast edifice in both its New Keynesian variety and its New Classical variety of attempting to place micro foundations under macroeconomics was not something that informed the policymaking process in any important way. Now to be fair, I have heard it said that if you actually wanted to know where a planet was, the Ptolemaic astronomical system did better than the Copernican astronomical system for 50 years after the world moved to Copernicus.

    “So a variety of that research may find its day, it may find its moment, but it wasn’t a moment that had enormous influence during this crisis, and it is my impression that it would be quite easy to graduate with a PhD in economics from many prominent economics departments in this country with only the vaguest notion of what the liquidity trap is, while at the same time being familiar with the substantial amount of subtlety surrounding dynamic stochastic general equilibrium. And that latter subtlety did not inform our policymaking process, and having read the policy prescriptions of those attached to dynamic stochastic general equilibrium, I’m not led to think that the world would have been an any better place had their laissez-faire type recommendations been pursued.”

    • Ok see where you are coming from blame the failure on Freshwater – we have added Salt. We old Keynsians aren’t tainted with the formalism of the New Keynsians. We can tweak IS/LM throw a nod to liquidity, Tobin Minsky and Kindleberger and we were right all along. Of course we never published any papers warning of structural problems in the great moderation or theoretical problems with the core assumptions of Samuelsson/Hicks derived neo-classicism – no because we have added salt and we are now properly seasoned – and that’s what we really thought all along. The Salty Dogs are proud of their foresight and world leadership in economic history, after all it enables you to rewrite it in your favour. Sing long into the Harvard night the salty sea shanties against the ‘splitters’.

      Ok there is a serious economic point here. That being that it is incoherent to use results derived from an endogenous credit theory of money without either acknowledging that theory or coming up with an laternative exogenous theory that comes up with the same results. Similar criticism to that levied at Krugman. Similarly for those who do acknowledge endogeity – like Nick Rowe and Isabella Kamainska – you cant carry along a lot of theoretical baggage (like IS/LM with its loanable funds assumption) that derives from exogenous monetary theory, you need to derive an alternative even if so far it hasn’t been derived.

      By the way though I very much enjoy Economic Professors commenting on here I would be much happier if they did so on one of my posts on monetary theory (such as my recent post criticising some of the key assumptions of MMT) or the contrsints on endogenous money creation or on entrepreneurship than on a rather throwaway gossipy post.

  4. Jeez, you wouldn’t believe the overtime we are having to work here in the Ministry of Truth to keep up with this.

  5. “That means trusting economists like Paul Krugman, Paul Romer, … Larry Summers, …and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.” ( DeLong)

    “The question for me is whether those in charge now, Summers for example, have learned their lesson and the humility to be derived from it, or whether they will be defensive of their own role to the extent that it affects the type of regulation they can support. I’d very much like to believe they have learned their lesson, though humility seems to be lacking,” ( Mark Thoma)

    Humilty in short supply, everywhere you look.

  6. “When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a “Luddite,” dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector.”

    “Just as they got the recent past right,…[Summers et al] are the ones most likely to get the distribution of possible futures right.” ( DeLong)

    Real problems here at the Ministry, Brad. We’re going to have to rewrite *everything*…

  7. DeLong: “I think the only constructive thing for me to do is to quote Martin Wolf and Lawrence Summers”…

    or, and here’s a crazy thought: Admit that you (and Krugman et. al.) were and are mistaken, and, for the good of your country (you are in a position of influence), concede that no useful policy advice can be devised without first recognizing the fundamental role of private debt in the economy.

    Stop wasting time on blogs defending yourself (and otiose ‘economics’) and test Keen’s ideas out more seriously.
    If they are wrong, show us why.

  8. DeLong: “I think the only constructive thing for me to do is to quote Martin Wolf and Lawrence Summers”…

    or, and here’s a crazy thought: Admit that you (and Krugman et. al.) were and are mistaken and, for the good of your country (you are in a position of influence), concede that no useful policy advice can be devised without first recognizing the fundamental role of private debt in the economy.

    Rather than defending obfuscation it might be more constructive to test Keen’s ideas out more seriously.
    If they are wrong, show us why.

  9. Pingback: Noah – Don’t Attack the Revolutionaries Leave Dinosaur Ideas on the Shore | Decisions, Decisions, Decisions

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