An article in today's FT (August 28, 2013) contains the following gloomy assessment of the tone at the Jackson Hole summit of central bankers.
The world is doomed to an endless cycle of bubble, financial crisis and currency collapse. Get used to it. At least, that is what the world’s central bankers – who gathered in all their wonky majesty last week for the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole, Wyoming – seem to expect.
Why would such an erudite gathering have reached such a conclusion and why are they right? It is a reflection of the fundamentally misguided view of financial economics which still largely prevails in academia and among policy makers and the financial elite.
Mainstream (neoclassical) economists see economic and financial behavior as manifesting, at the macro level, economically stable equilibria which are the outcome of a utility optimizing function by a collection of rational economic agents. Under this framework, financial crashes are due to exogenous factors. That is, within the modeling tools that they use to explain system wide economic circumstances, there is no explanation, other than abnormal shocks, which are “outside” the scope of their models, to explain why bubbles become unsustainable and eventually burst resulting in very damaging financial crashes. Mainly because they lack a proper framework for explaining the role of money and credit within financial capitalism they can only resort to something extraneous to account for the disequilibrium crash events which have punctuated economic history.
In more general terms, the neoclassical school is unable to explain the nature of credit and its role in the development of asset bubbles precisely because it fails to offer a satisfactory account for endogenous credit creation and the role of credit/debt in financing investments which can and will lead to unsustainable bubbles. Hyman Minsky outlined his intention to remedy this critical defect in the neoclassical tradition right at the beginning of his book Stabilizing an Unstable Economy .
“We will develop a theory explaining why our economy fluctuates, showing that the instability and incoherence exhibited from time to time is related to the development of fragile financial structures that occur normally within capitalist economies in the course of financing capital asset ownership and investment.”
A pithy statement of the opposition to the neoclassical tradition and its marginalization of the insights which Hyman Minsky had with respect to the role of financing in a modern economy – and its associated instability - is also revealed in this quote from Steve Keen during a US television interview. It also alludes to the dispute between himself, Randall Wray and several other economists not within the mainstream (yet), and Paul Krugman which has been ongoing:
You can’t model the economy without including the role of banks, debt, and money. And Krugman’s part of the economic establishment, which for thirty or forty years has got away with arguing that you can model a capitalist economy as if it had no banks in it, no money, and no debt… You just don’t have a model of capitalism if you don’t include those components.
While this cursory discussion may seem abstruse and theoretical a lot hinges on the endogenous/exogenous dichotomy. By situating the "causes" of financial bubbles and their ensuing crashes as due to exogenous factors, the central bankers and policy makers can absolve themselves of the ultimate accountability for creating such bubbles. If the assumptions of the endogenous money creation view were to be fully integrated into mainstream financial economics we might eventually be on a path to ridding ourselves of the recurring nasty shocks that, it is usually claimed from a self-serving perspective, no-one could possibly have foreseen, and which are largely the "unintended consequences" of wilful ignorance.