Earlier in the week, Brad DeLong approvingly linked to a piece by Christopher Hayes in the American Prospect on the matter of economic cycles. Hayes asks some questions that he admits rarely appear in political commentary: Are they necessary? And, more provocatively, are they good? The questions in fact are relevant to our situation, and encompass a fairly large swath of economic history. And they offer an interesting perspective on the debate that's been bubbling all week, mostly in the Financial Times, over "austerity."
Indeed, the FT wraps up the week Friday, July 23, with a passionate cry (if a central banker can passionately cry) by European Central Bank chief Jean-Claude Trichet for G-20 nations to start "consolidating," meaning tightening, immediately. The FT mischeviously places Trichet's jeremiad beneath a piece by Montek Singh, the deputy chairmen of India's government planning commission, begging the G-20 not to cut too soon. All of which tells you a lot about the G-20 and continuing fundamental differences over economic policy.
But back to the cycles. Hayes, The Nation's Washington editor, has discovered a few things that the financial crowd has long known. Cycles are controversial. Some believe cycles can be eliminated, or at least significantly diminished; these sentiments, as Hayes points out (though he overstates it slightly), were popular among the free-market crowd before the financial crisis -- particularly the belief among macroeconomists like Robert Lucas that economic tools and expertise had matured to such an extent that depressions could be eliminated as a threat. There is, in fact, a long history of such statements; the general acceptance of such hubris, whether it applies to bank crises (Citibank's John Reed in the late '80s that cyclicality was over, just before his bank almost folded under bad loans) or to market boom and busts (the widespread belief of technophiles in the dot-com bubble that market cyclicality, at least in term of tech, was over) is, in retrospect, a clear symptom of trouble.
There is a link here between belief in "the end of cyclicality" and confidence that economics and finance have grown more "scientific," which is another way to say predictive. Some of the overleveraging that led to the disaster of 2008 on Wall Street can be attributed to the belief that risk management actually worked; by giving firms a firmer grasp of risk, they could take on more leverage and make bigger bets. (Some of this was nurtured by the long bull market, the Great Moderation; and excessive risk-taking was clearly fueled by both greed and competition.) This is a position that is seductive because of its Newtonian rationality. The uncertainty of the future Keynes wrote so much about can be erased, or at least diminished. Cause and effect, that is past and future, which often seem to have a perilously fraught relationship in markets, can be reconciled on a more robust basis. Certainty, predictability and control re-emerge. Confidence soars. A New Era dawns.
Then there are the believers in the inescapability of cycles. As Hayes correctly points out, much of Wall Street (particularly today) believes in cycles. How could they not? Cycles have been aspects of markets, and economies, as long there have been markets. But beyond that fundamental belief, the situation gets very murky. Hayes works very hard to define two camps based on their view of cycles, which he then forces into a standard political alignment: Keynesian liberal versus free market conservative (or neoliberal). He uses two texts: Robert Samuelson's argument that recessions are necessary to wring inflation out of a system, "The Great Inflation of its Aftermath: The Past and Future of American Affluence," and Paul Krugman's "The Return of Depression Economics," which seeks a return to Keynesian policies to combat economic crises. (These two texts could easily fit into the FT's "austerity" debate: Samuelson for, Krugman against.)
In fact, both camps believe that cycles exist. Samuelson does not
take the view that "progress" has resolved the issues of booms and
busts. Hayes has a tendency here to confuse market optimism with a
belief that the promised land had been reached (even Lucas was speaking
about avoiding the ultimate economic breakdown, depressions, not
eliminating cycles: Hayes tends to drift back and forth between the
two. In fact, Lucas had a point, because we seem to have avoided
depression through aggressive central banking). Indeed, even in the
midst of the Great Moderation, even at the zenith of the Clintonian
Washington Consensus, there was a recognition that cycles would still
occur, but that they could be "managed." And in fact the split that
Hayes zeroes in on between Samuelson and Krugman really has to do with
what tools are required to "manage" those pertubations. Krugman has
long been a pessimist; his popular writings in the early years of the
Clinton administration, for instance, were sunk in gloom over American
productivity, growth, deficits and competiveness, just before the sun
came out (and yes, the sun goes down with great regularity). That said,
his tool kit includes much that Keynes would recognize: fiscal and
monetary countercyclical policies to reduce pain and smooth the cycles.
Samuelson favors fiscal discipline and the what he would see as the
cleansing effect of downcycles.
The real difference between the two then is more moral and metaphorical than technical. Samuelson sees good times creating excess and distortions -- there is a kind moral prescription here: we were living beyond our means -- that needs to be cleared in a downturn. This is the Calvinist approach: our economic well-being reflects our state of sin or grace. At the end of the day, cyclicality and crises are caused by bad behavior -- greed, speculation, stupidity, overreaching. Krugman, channeling Keynes, approaches it very differently. Downturns are not moral gotterdamerungs (although, both Krugman and Hayes easily opt for the moral, even criminal, critique when it comes to, say, Wall Street versus Main Street.) They are technical challenges of deficient demand and uncertainty. "Bad things," Hayes quotes Krugman, "can happen to good economics."
"More broadly, Krugman's point is that, contra Samuelson, recessions, and depressions and assorted downturns are not useful, cleansing opportunities to 'purge the rottenness out of the system,' but more often vicious cycles, auto-catalytic processes that result in massive amounts of human suffering, and waste human capital and an economy's productive capacity. More like the forest fire caused by a careless camper than the natural cleansings produced by mother nature."
Who can disagree with Hayes paraphrasing Krugman that "economies
need management and policy to maintain some kind of equilibrium?" But
in arguing that markets can be effectively managed with the correct
policies, Hayes is inadvertantly stepping into an expectations trap.
Cycles might not be moral gotterdamerungs, but that Keynesian
uncertainty cannot be wished away, as far as we can tell, by even the
wisest policies, or for that matter the best regulation. Excess and
imperfection (which may include ineradicable regulatory capture) may
not be moral categories, but they exist and they accumulate -- and at
some point the piper must be paid; mistakes, bad bets, recklessness are
cleared. And if there's one thing we know about markets, it's that the
very belief in economic management or market omniscience creates the
kind of hubris and excess that tips us into the next cycle. This, in a
sense, is the contradiction -- in Biblical terms, the snake in the
economist's garden -- that can't be driven out by mere thinking mortals.
- Robert Teitelman
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