The present economic crisis that started in 2007 encouraged critics to raise the question whether economists could not have predicted the crisis, suggesting timely corrective measures.
A more pertinent question is whether economics, more particularly modern mainstream macroeconomics (MMM) is in a position to analyse the present crisis and able to come forward with appropriate policy measures?
Could MMM have successfully identified (flagged), understood and given early advice to counter the factors responsible for this latest crisis?
The answer to these questions is an unambiguous "no" as MMM has already for a long time not been geared for the kind of complexities that were ultimately encountered.
Markets and human behaviour
There were certainly some economists who analysed global developments prior to the present crisis and whose conclusions clearly indicated the serious consequences likely to follow if these issues were left unattended.
One example is the major international imbalances developing in recent years between saving surplus and saving deficit countries.
Another example is the exuberant behaviour of market participants in certain instances, such as the property market during recent years (but not limited thereto). Behavioural economics devoted much attention in analyzing the causes and likely effects of these developments.
In contrast, the MMM approach to economic crises makes key assumptions about the way markets operate and about human behaviour generally that did not prove realistic.
MMM sees markets as stable and basically self correcting. This view of the smooth market adjustment process implies that the forces in favour of equilibrium are always overruling those of disequilibrium. An important corollary is that government intervention in markets is destabilising. Government action is seen as disrupting the equilibrating forces and cannot contribute towards equilibrium. In the event of a disturbing experience the typical MMM approach would be to allow the distortion to develop on its own because it is easier to clean up after the event.
This analysis is not very helpful during economic crises because during such events disequilibrating forces tend to overrule. Moreover, Keynesian economics clearly argued in favour of government intervention in such circumstances, such as depressions, in order to support the forces working towards equilibrium. MMM caricatured this as fiscal activism.
Apart from a distorted perception of market functioning, MMM cannot deal effectively with crises because of its Walrasian analytical elements. The main shortcoming here is that the resulting analysis does not take cognisance of uncertainty.
In Walrasian analysis uncertainty is overcome through the means of creating a Walrasian auctioneer who disseminates information without charge. Market participants are now in a position to trade towards equilibrium and in the event of misjudgment are allowed to do recontracting.
MMM substitutes rational expectations for the Walrasian auctioneer. Thus economic agents are assumed to have full information at zero cost as displayed by the relevant economic model. Also, economic agents do not make systematic mistakes.
In essence, MMM assumes information dissemination at zero cost, thereby facilitating the introduction of the Walrasian property of instantaneous adjustments in markets. This feature of Walrasian analysis encourages the development of general equilibrium analysis dealing with the interrelations between markets in achieving simultaneous equilibrium.
Yet such outcomes have little reference to the real world where all these conditions are not met and where calendar time prevails.
Human behaviour is an important element in explaining the actions of market participants. This has been an important element in the development of economic theory. In the historic evolution of macroeconomics these elements featured explicitly in the work of Keynes and others who followed.
MMM has historically developed an intellectual framework that could not successfully conduct an analysis of the forces shaping the global economic crisis that started in 2007. Moreover, this analysis failed in developing a coherent policy framework to deal effectively with the crisis.
A more pertinent question is whether economics, more particularly modern mainstream macroeconomics (MMM) is in a position to analyse the present crisis and able to come forward with appropriate policy measures?
Could MMM have successfully identified (flagged), understood and given early advice to counter the factors responsible for this latest crisis?
The answer to these questions is an unambiguous "no" as MMM has already for a long time not been geared for the kind of complexities that were ultimately encountered.
Markets and human behaviour
There were certainly some economists who analysed global developments prior to the present crisis and whose conclusions clearly indicated the serious consequences likely to follow if these issues were left unattended.
One example is the major international imbalances developing in recent years between saving surplus and saving deficit countries.
Another example is the exuberant behaviour of market participants in certain instances, such as the property market during recent years (but not limited thereto). Behavioural economics devoted much attention in analyzing the causes and likely effects of these developments.
In contrast, the MMM approach to economic crises makes key assumptions about the way markets operate and about human behaviour generally that did not prove realistic.
MMM sees markets as stable and basically self correcting. This view of the smooth market adjustment process implies that the forces in favour of equilibrium are always overruling those of disequilibrium. An important corollary is that government intervention in markets is destabilising. Government action is seen as disrupting the equilibrating forces and cannot contribute towards equilibrium. In the event of a disturbing experience the typical MMM approach would be to allow the distortion to develop on its own because it is easier to clean up after the event.
This analysis is not very helpful during economic crises because during such events disequilibrating forces tend to overrule. Moreover, Keynesian economics clearly argued in favour of government intervention in such circumstances, such as depressions, in order to support the forces working towards equilibrium. MMM caricatured this as fiscal activism.
Apart from a distorted perception of market functioning, MMM cannot deal effectively with crises because of its Walrasian analytical elements. The main shortcoming here is that the resulting analysis does not take cognisance of uncertainty.
In Walrasian analysis uncertainty is overcome through the means of creating a Walrasian auctioneer who disseminates information without charge. Market participants are now in a position to trade towards equilibrium and in the event of misjudgment are allowed to do recontracting.
MMM substitutes rational expectations for the Walrasian auctioneer. Thus economic agents are assumed to have full information at zero cost as displayed by the relevant economic model. Also, economic agents do not make systematic mistakes.
In essence, MMM assumes information dissemination at zero cost, thereby facilitating the introduction of the Walrasian property of instantaneous adjustments in markets. This feature of Walrasian analysis encourages the development of general equilibrium analysis dealing with the interrelations between markets in achieving simultaneous equilibrium.
Yet such outcomes have little reference to the real world where all these conditions are not met and where calendar time prevails.
Human behaviour is an important element in explaining the actions of market participants. This has been an important element in the development of economic theory. In the historic evolution of macroeconomics these elements featured explicitly in the work of Keynes and others who followed.
MMM has historically developed an intellectual framework that could not successfully conduct an analysis of the forces shaping the global economic crisis that started in 2007. Moreover, this analysis failed in developing a coherent policy framework to deal effectively with the crisis.
No comments:
Post a Comment