Wednesday, April 7, 2010

An Insightful Talk at an Important Conference

William White, former chief economist of BIS and one of the few who foresaw and warned policymakers on the economic crisis, explains the causes of the economic crisis in a talk he is to give at an upcoming conference (hat tip Mark Thoma):
While private sector behavior (“procyclicality”) played a crucial role in this event, central banks also contributed heavily. It is likely not a coincidence that the expansion phase of the last credit cycle began with policy rates at their lowest in the major industrial countries. As well, with increases in policy rates carefully signaled, there was an open invitation to take on more leverage in response to declining carry margins as policy rates rose. Further, in emerging market countries, upward pressure on their exchange rates was fiercely resisted through both FX intervention and easier monetary policy. In this way, the problem of excess “liquidity” became truly global. Finally, it is not farfetched to suggest that many of the developments that made this crisis “different” were also encouraged by low policy rates. These led to more risk taking in ”the search for yield”, as well as efforts (off balance vehicles and new instruments) to disguise these risks. Unfortunately, disguised risk is not the same as reduced risks, as eventually became apparent.
I would summarize his three points above as follows: (1) central banks in advanced economies kept interest rates far below their neutral level which created a credit boom, (2) this excessive monetary easing in the advanced economies spread to the emerging market economies through their exchange rate policies (e.g. the dollar bloc countries imported the loose U.S. monetary policy), and (3) the low rates in the advanced economies created further distortions via the risk taking channel. All of these developments were compounded by the procyclicality of the financial system. I couldn't agree more.

White goes own to discuss the need for a new analytical framework, one the incorporates the best of Keynesian, Austrian, and Minskyian insights. This is a point he made earlier in an IMF paper. This looks to be an interesting conference with many important thought leaders participating.


  1. I think Marx and Schumpeter and Minsky had it right - credit and economic cycles are part of the natural rhythm of capitalism. The Austrian school with its ideological blinkers simplistically tries to pin it onto the central bank, but like monetarists, they are deceived by the shadow of money projected by the real factors. Money is naturally elastic in response to the real business cycle driven by expectations about future MPK.

  2. I agree on the need for a synthesis, plus some brand new insights.

    One thing I think the Austrians don't understand is that in a democracy, it is impossible for the government to stand by while people suffer.

    As long as they are that ignorant of human nature, it is hard to take much of their proscriptions seriously.

    If we were going to grab some important ideas from each of these schools:


    1. People cannot figure out the wants of other people well. The market is the best tool we know for figuring out what people want.
    2. Businesses can fail and that is good. We want some things to fail so we can create new better businesses.


    1. Realized/effective demand is hugely dependent on what is happening with money. There are times where effective demand is way lower than it should be for nominal reasons and not real reasons.
    2. Businesspeople are crazy in a good way. We should use this craziness to the advantage of the economy in more ways than we are.

    1. During good times, more risky behavour is overly rewarded. To paraphrase, bad risk drives out good risk.
    2. People like to lend and borrow money so much they re-create the same problems over and over. We should force banks to be simple orginizations.

    There are lots more, but this is a first list.

    here is something that I think needs to be recognized and incorporated into any paradigm: Light and proper regulation is superior to heavy or no regulation.

    One more thing is that because fiat currencies are new, they don't understand the mosler paradigm. Once you understand the mosler paradigm, some of the things we are concerned with now simply go away.