Keynes – The best way to think of the Financial Crisis

3 take Aways

1. We should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”.

2. The economy cannot be analyzed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so.

3. One should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behavior guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

Markets are neither infallible or dispensable. They are indeed the underpinnings of a productive economy and individual freedom. But of course, they can also go seriously awry and so must be managed with care. The election of Mr Obama surely reflects a desire for just such pragmatism. Neither Ron Paul, the libertarian, nor Ralph Nader, on the left, got anywhere. So the task for this new administration is to lead the US and the world towards a pragmatic resolution of the global economic crisis we all now confront.

The urgent task is to return the world economy to health.

The immediate shorter term challenge is to retain aggregate demand, as Keynes would have recommended. This will put more pressure on the bankers for loans. It’s evident that most of the pressure will be on the US as the Europeans, Japanese and even the Chinese are too inert. Although the decreased spending of households is expected to last for a few more years, a big effort must be made to purge the balance sheet of households and the financial system.

The long term challenge is get the global demand rebounding to a proper balance. It’s foolish to expect deficit countries to spend away into bankrupty, while well to do countries condemn as profligacy the spending from which their exporters benefit so much.

It is also essential to construct a new system of global financial regulation and an approach to monetary policy that curbs credit booms and asset bubbles. There seems to be no clear answer to this problem, but recognition of the frailness of the system would be a fair start.

We are faced with a dichotomy of choices: to deal with the challenges co-operatively and pragmatically or let ideological blinkers and selfishness blind us. The focus should be on preserving an open and reasonably stable world economy that offers opportunity to much of humanity as possible. It’s not that we haven’t done this so far, but we must do better.

The biggest lesson of crisis would be as Oscar Wilde would have it ‘In Economics, The truth is rarely pure and never simple’.

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