Friday, April 23, 2010

Joe Stiglitz on R. Skidelsy and his new book on Keynes

Robert Skidelsky has published a new book, 'Keynes: The Return of the Master', and my ex-student Alexandros Stavrakas who is now editor-in-chief of Bedeutung, a magazine of Philosophy, Current Affairs, Art and Literature was kind enough to bring to my attention a review of the book written by Joseph Stglitz.

Here are the opening paragraphs:
It has become a commonplace to say, in the aftermath of the Great Recession, that ‘we are all Keynesians now.’ If this is so, then Keynes’s great biographer, Robert Skidelsky, should have much to say about the recession, its causes and the appropriate cures. And so indeed he does. I share with Skidelsky the view that, while most of the blame for the crisis should reside with those in the financial markets, who did such a poor job both in allocating capital and in managing risk (their key responsibilities), a considerable portion of it lies with the economics profession. The notion economists pushed – that markets are efficient and self-adjusting – gave comfort to regulators like Alan Greenspan, who didn’t believe in regulation in the first place. They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression; and they gave justification to those, like Larry Summers and Robert Rubin, Treasury secretaries under Clinton, who opposed doing anything about derivatives, even after the dangers had been exposed in the Long-Term Capital Management crisis of 1998.

We should be clear about this: economic theory never provided much support for these free-market views. Theories of imperfect and asymmetric information in markets had undermined every one of the ‘efficient market’ doctrines, even before they became fashionable in the Reagan-Thatcher era. Bruce Greenwald and I had explained that Adam Smith’s hand was not in fact invisible: it wasn’t there. Sanford Grossman and I had explained that if markets were as efficient in transmitting information as the free marketeers claimed, no one would have any incentive to gather and process it. Free marketeers, and the special interests that benefited from their doctrines, paid little attention to these inconvenient truths.

The review is, of course, much more than a review so it would be a good idea to read it and get a sense of how things are in the profession and in the world right now.

On page 5 of the article Stiglitz discusses the situation that Greece and other PIIGS are facing:'
... There are speculative attacks against the weakest countries, which find themselves caught between a rock and a hard place. They worry that deficits will lead to higher interest rates, not because (as is usually argued) public spending will crowd out private spending, but because of growing ‘risk premiums’. But the effect is much the same: more government spending will force cutbacks in private spending, with the obvious adverse effects on the economy. The financial markets that caused the crisis – which in turn caused the deficits – went silent as money was being spent on the bail-out; but now they are telling governments they have to cut public spending. Wages are to be cut, even if bank bonuses are to be kept.

If markets were rational, there would be an easy policy response. Spending on investments that yielded even moderate real returns (say, of 5 to 6 per cent) would lower long-term debt levels; such spending increases output in the short run, thus garnering more tax revenue, and the future returns generate still more tax revenue. If markets could be convinced, for example, that European governments can and will meet their debt obligations, interest rates would fall, and even the countries with the highest levels of debt would find it easy to meet their obligations. But markets are not necessarily rational, and even when they are, they are not always well intentioned. The objective of a speculative attack is to generate profits for the speculators, regardless of the cost to the rest of society. They can make money by inducing panic and then feel pleased with their ‘insight’: their concerns were justified, but only because of the responses to which their actions gave rise.

Since the time of Keynes, the ability of markets to mount such speculative attacks has increased enormously. But governments are not powerless to tame them, and in some cases can counter-attack, as Hong Kong did in foiling Wall Street’s famous ‘Hong Kong double play’, when speculators simultaneously sold short both the currency and the stock market. The speculators knew that governments traditionally respond to a currency attack by raising interest rates, which lowers stock prices. If Hong Kong failed to raise interest rates, they would make money by shorting the currency. If Hong Kong did raise them to save its currency, the speculators would make money by shorting the stock market. Hong Kong outsmarted them by simultaneously raising interest rates and supporting the stock market by buying shares. Taxes on short-term capital gains, regulations on the ever more powerful speculative instruments (like credit default swaps), and – especially for developing countries – the imposition of barriers on the uncontrolled movement of short-term capital across borders, can reduce the scope for and returns from this kind of behaviour.

The article is found here.

PS: May 2010 IB candidtates taking the Higher or Standard Level Economics exam on May 19/20 should definitely read this and take down a couple of notes. Examples and awareness of what is going on in the world are always much appreciated by examiners. Do not forget that. Even a mediocre essay will earn higher marks if it includes some relevant examples.

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