Why was the 2008 Global Financial Crisis such a surprise to a surprising number of economists? A new book, Understanding Global Crises: An Emerging Paradigm by Assaf Razin, suggests one reason is the mental blinkers imposed by the real business cycle worldview, whereby productivity shocks and nominal wage stickiness accounted for most cyclical fluctuations – as long as monetary policy was sensibly guided by a rule that avoided policy shocks. That complacency (as it turned out) has of course evaporated, leaving instead agreement about some aspects of the macroeconomic problem – the zero lower bound problem and role of “unconventional” QE – and wild disagreement about fiscal policy.
The book starts with a history of the financial crises of the 1990s and 2000s – and you only have to see that history (the Asian crisis, LTCM, the dot com bubble) to be puzzled anew by the widespread belief in permanent stability by the mid-2000s. The second part looks at the various sources of financial fragility: asymmetric information, risk-shifting and risk-taking, excessive optimism, and co-ordination failures. This section presents a model of the optimal amount of insurance against risk-taking financial institutions, taking account of the moral hazard and adverse selection problems. The third section turns to currency and balance of payments crises, and the Eurozone’s unpalatable choices. It is a relatively short book covering in a very elegant way a lot of theoretical and historical territory.
The book concludes that some vital questions remain unanswered by the latest dynamic general equilbrium models it presents – including the most bitterly-disputed policy questions: when should fiscal austerity be implemented to reduce debt levels and unfunded demographic liabilities; when should monetary policy start to be tightened; when does the need to stabilise the financial system outweigh the risks of moral hazard.; and how should monetary policy take account of asset price bubbles during the zero/low interest rate period? These seem pretty fundamental, which I suppose will keep macroeconomists busy for some time.
The book is based on courses Prof Azin has taught since the crisis, and is geared towards a graduate student audience, so it is not one for the general reader interested in the sorry state of the global economy and financial markets, post-2008. It looks like a must-read for relevant courses, however. To me – with a foot in the academic camp but not remotely expert in global macro or finance – it also looks like it’s retrofitting economic theory to events. It is good to have it demonstrated so clearly, as many macroeconomists have assured me, that macro models can accommodate the kinds of event we have experienced in life. But it leaves unanswered the original puzzle – why did so many macroeconomists wear the real business cycle blinkers in the first place?
I picked up Karl Popper’s The Poverty of Historicism earlier this week. He is arguing against those social scientists who see laws of progress in operation, those who, “Believe that their own advance has been made possible by the fact that we are now ‘living in a revolution’ which has so much accelerated the speed of our development that social change can now be directly experienced within a lifetime.” However, he adds, “Change has been discovered over and over again.” There is nothing new in this enthusiasm for modern times. “Since the days of Heraclitus, change has been discovered over and over again.”
The Poverty of Historicism is very much a book of its own time (1957): it’s hard to imagine anyone today writing this, about the most important difference between the natural and the social sciences: “By this I mean the method of constructing a model on the assumption of complete rationality (and perhaps also on the assumption of the possession of complete information) on the part of all the individuals concerned.” Human beings, he says, are not perfectly rational, but they are more or less rational. “There are good reasons, not only for the belief that social science is less complicated than physics, but also for the belief that concrete social situations are in general less complicated than concrete physical situations.”
I don’t think he’d have many takers for that argument today. Progress?
Although I don’t teach or practice macroeconomics, if I did I’d certainly be thinking of using the new textbook from Wendy Carlin and David Soskice, Macroeconomics: Institutions, Instability and the Financial System. As the subtitle so clearly indicates, this book does absolutely engage with the messiness of the post-crisis real world. Its aim is to stay simple enough for undergraduate use while also realistic enough to empower its readers to understand the why and how of the financial crisis and to evaluate macroeconomic policy. For graduate students or practising economists wanting a reference book, this offers a tractable, intuitive model that combines the standard 3-equation approach with the insights of Hyman Minsky (mentioned in the Preface) and institutional realism.
The first chapters set out the standard 3-equation model, and chapters on expectations and money & banking follow. The latter includes a description of how a modern banking system works (no whiff of a money multiplier!). Two chapters on the financial sector and the crisis follow – including topics like balance sheet recessions, QE, and a discussion of austerity policies. There is a chapter on innovation, growth and fluctuations – Solow, endogenous growth and Schumpeterian growth. Next comes a section on the open economy, with separate chapters on oil shocks/commodity prices and the Eurozone.
The final chapters cover monetary and fiscal policies, supply side policies and the labour market, and a final chapter on real business cycles and the New Keynesian approach.
This is certainly the first textbook I’ve spotted to have incorporated the lessons of the crisis, and it does so very elegantly, keeping the modelling framework reasonably simple. The book also weaves in the events of recent economic history, and applies the models it develops to actual events, so students do not have the dispiriting experience of being taught an economics in the classroom divorced from the kind of economics they hear about in the news.
I’m a big fan of Wendy’s already, having had the pleasure of working with her on the CORE curriculum and e-book; and this new textbook confirms my opinion. I’ve dipped in to specific chapters that I can evaluate properly, such as the one on growth and the supply side and labour market sections – perhaps if I read the whole book properly it will cure me of my ingrained macro-scepticism……
Some time ago I co-authored a report (for the UN Foundation and Vodafone Foundation) with Patrick Meier on the use of mobiles in emergencies and disasters. Patrick has just released a whole book on this subject, going much wider than the original report, Digital Humanitarians: How Big Data is Changing the Face of Humanitarian Response.
The technology has already moved on considerably – the Big Data phenomenon, for one thing. Importantly, there’s a chapter covering verification techniques; while we found in the original work that crowd-sourced data (as it wasn’t yet called when we first wrote about this) was often more accurate than ‘official’ information, the more verification the better. There’s also a chapter on digital activism – the book’s website sets out all the chapters with brief summaries.
Digital Humanitarians looks like it has lots of examples and it certainly covers some very important and timely questions. Patrick blogs at iRevolution and his latest post talks about the book.
By the time I had to head back to the station yesterday, I’d almost finished reading the manuscript I’m reviewing, so I borrowed Karl Popper’s The Poverty of Historicism from the shelves of my University of Manchester office mate John Salter (as he teaches political economy, and theories of justice, he has a fine and tempting collection of classics).
I’m not very far into it yet, but it’s striking that Popper excludes economics from his pronouncements about methodology in the social sciences. Eg, “I am convinced that such historicist doctrines of method are at bottom responsible for the unsatisfactory state of the theoretical social sciences (other than economic theory).” No doubt all will be revealed, but it’s surprising to read this at a time when economics is widely criticised.