Do I agree with Steve Keen's views about the causes of the GFC and the NAR?

Who is Steve Keen? What is the NAR? And why am I wondering whether or not I agree with Steve Keen?

Steve Keen is an Australian economics professor, author of a book entitled ‘Debunking Economics’. His blog, ‘Steve Keen’s Debtwatch’, is dedicated to analysing ‘the collapse of the global debt bubble’. The NAR refers to the North Atlantic Recession, sometimes referred to as the Great Recession, that followed the GFC. I am wondering whether or not I agree with Steve Keen because of a comment on Jim Belshaw’s blog last Sunday. Jim wrote:

‘The second part of Winton's post focused on Irving Fisher's views is, if I interpret the argument correctly, very similar to views expressed by Professor Keen. Essentially, a key part of the problem was the combination of levels of private debt with income and price variations.’

Jim was referring to a post on this blog a couple of weeks ago: ‘Should the GFC be viewed as a 'balance sheet' recession of the kind Irving Fisher wrote about in the 1930s?’

My immediate response was to question whether it might be possible that I could express views similar to those of Professor Keen. While my views on economics have strayed somewhat from neoclassical orthodoxy in recent years, I still consider that the concept of equilibrium provides a useful starting point for economic analysis. Steve rejects all conventional neoclassical economics.

If my understanding is correct, there are two main elements involved in Steve’s views about the causes of the GFC and the following recession: Minsky’s financial instability hypothesis; and the concept of endogenous money creation.

Minsky’s financial instability hypothesis involves the idea that a growing economy is inherently unstable. Investments are initially conservatively financed, but it gradually becomes evident to managers and bankers that greater profits can be made by increasing leverage. Investors and bankers come to regard the previously accepted risk premium as excessive and to evaluate projects using less conservative estimates of prospective cash flows. The decline in risk aversion sets off growth in debt, growth in investment and growth in the price of assets. The euphoria is eventually brought to an end as rising interest rates and increasing debt to asset ratios affect the viability of many business activities. Holders of illiquid assets attempt to sell them in return for liquidity. The asset market becomes flooded, panic ensues, the boom becomes a slump and the cycle starts all over again. (That is an abridged version, excluding Ponzi elements, of a summary which Steve provides in his paper: ‘A monetary Minsky model of the Great Moderation and the Great Recession’).

The concept of endogenous monetary creation involves the idea that banks create credit in response to demand. If a bank lends me money, my spending power goes up without reducing anybody else’s. So, bank lending creates new money, and adds to demand when it is spent. From this perspective, ‘aggregate demand is income plus the change in debt’. (My training in economics and national income accounting makes it difficult for me to understand why or how that can be so. Nevertheless, let us proceed.) If my understanding is correct, Steve is arguing that quantitative easing does not increase the money supply, because banks don’t increase lending when central banks purchase bonds from them. (See Steve’s article: ‘Is QE quantitatively irrelevant?’).

My objection to the first element arises because I don’t understand why a growing economy should necessarily be unstable.  In my view, it is necessary to introduce into the analysis a ‘too big to fail’ policy, or something similar, to explain why banks have a tendency to take excessive risks. I have attempted to outline the regulatory issues involved in a previous post:

‘Governments seem to have managed somehow to get us into a vicious cycle where fears of contagion have led them to encourage major financial institutions in the believe that they were too big to fail, while the belief that governments would bail them out has led major financial institutions to take excessive risks. If we can't let big financial institutions fail when they become insolvent, perhaps the next best option is to find the least cost way of regulating them to make it less likely that they will become insolvent’.

My objection to the concept of endogenous monetary creation is that it flies in the face of the reality that monetary policy can increase and reduce the rate of growth in nominal GDP (aggregate demand). It would make more sense to explain the fact that money creation through quantitative easing did not result in an immediate increase in bank lending in terms of funds being used to meet demands for liquidity (or repair balance sheets) than to redefine the concept of money in order to claim that the money was not created.

   

In my view Scott Sumner is on the right track in arguing that nominal GDP level targeting (along a 5% growth rate) in the United States before 2008 would have helped greatly reduce the severity of the Great Recession:

‘One reason asset prices crashed in late 2008 is market participants (correctly) saw that the Fed had no plan to bring the US economy back to the old nominal GDP trend line’ (See: ‘A New View of the Great Recession’, Policy, Winter 2013. The article is gated, but Scott has expressed similar views on his blog.)

The idea of targeting nominal GDP, to bring it back to the old trend line seems to me to be similar to Irving Fisher’s advocacy of reflation, as discussed in my post about balance sheet recessions.

So, coming back to the original question, I agree with Steve Keen that debt is important in explaining the GFC and the NAR, even though I have a very different view about the way economic systems work.

Why was Tipperary 'prime in crime' in the early 1800s?

This question arose from my reading of ‘The Two Tipperarys’, by Donal Murphy. The book is primarily about the division of Tipperary into north and south counties in 1838. It was recommended to me as background reading on the life and times of people living in Tipperary in the 19^th Century. (I have some ancestors who came from that part of the world.)

Tipperary was apparently relatively peaceful during the Butler palatinate from c. 1200 to the early 1700s. By the mid 1830s, however, the county had established an unrivalled reputation for lawlessness. In 1836, the number of people committed for trial in Tipperary amounted to about 1.4 per cent of the population of that county, whereas the corresponding percentage for Ireland as a whole was 0.3 per cent.

After comparing the data of numbers of people committed for trial with data on the numbers of crimes reported, the author comments:

‘A crude comparison between the two sets of ratios seems to suggest that a higher number of persons per crime was also a Tipperary phenomenon – perhaps an early indication of a co-operative spirit in the county’.

There is also some evidence suggesting that a greater amount of crime went unprosecuted and unpunished in Tipperary than other counties. At the time, one judge described ‘a system of terror’ creating greater difficulties in administration of justice in Tipperary than in other counties. Another reason for many victims to be reluctant to report crimes would have been their limited faith in the administration of justice.

Donal Murphy does not devote much space to discussion of the causes of the high crime rate in Tipperary because it isn’t relevant to the main theme of his book. He suggests distress and famine as a contributing factor, with a crop failure in 1834 being described as a preview of the Great Famine which occurred a decade later. He also mentions ‘the flourishing state of faction fighting, violence for the sake of violence’. This involved personal and community vendettas erupting in gang warfare at town fairs. A variety of groups are mentioned, including the Caravats and Shanavests.

My search for more information about the Shanavests and Caravats led me to Paul Roberts’ contribution entitled ‘Caravats and Shanavests: Whiteboyism and Faction Fighting in East Munster, 1802-11’, published in ‘Irish Peasants, Violence and Political Unrest 1780 – 1914’, edited by Samuel Clark and James Donnelly. Whiteboyism is a generic term referring to outbreaks of agrarian terrorism between 1760 and 1845, primarily aimed at redressing economic grievances of poor farmers and rural labourers. This action was mainly directed against the rural middle class who were their immediate landlords, as a result of various forms of subletting.

The Caravats have their origins as primarily a Whiteboy movement and the Shanavests as primarily a middle-class anti-Whiteboy movement. Both groups were known by different names in different areas.

Paul Roberts suggests that Caravatism was the product of the wartime agricultural boom of 1793-1813, which increased demand for food and resulted in higher rents. This benefited the middle classes, who had long leases, and disadvantaged the poor, who were not protected by leases. The Caravats used terror against better-off farmers and other middle-class elements in an attempt to guarantee the poor access to land and food. Some of their gangs were also involved in other criminal activities such as highway robbery.

The Shanavest movement had links to nationalist political organizations, but it arose in direct response to Caravatism. Its activities included murders and assaults directed against prominent Caravats. Apparently, the political and religious alienation of the middle class from the state inclined them to look to their own resources, rather than to rely on the state for protection.

The activities of the Caravats and Shanavests began in the south of Tipperary, but by 1809-10 had moved to the north of the county and to other counties. The authorities intervened by increasing troop numbers, holding a special commission and arresting forty men involved in the disturbances. This brought the Caravat-Shanavest outbreak under control, but the two movements seem to have lived on with open feuding being pursued under a series of regional names.

Paul Roberts suggests that the economic basis of the feud would have weakened over time as nationalism gained ground among the poor between 1815 and 1845, and the worsening economic situation of the rural middle class after 1813 created fertile soil for cooperation across class divisions. That would explain why Donal Murphy describes the faction fighting in the 1830s as ‘violence for the sake of violence’.

In writing about ‘the good society’ on this blog and elsewhere, I have put a great deal of emphasis on the need for people to be able to live in peace with one another in order to enjoy the benefits of economic and social progress. The history of Ireland in the early part of the 19^th Century shows just how difficult it can be for people to live in peace when different groups perceive that others are treating them unfairly.

Should the GFC be viewed as a 'balance sheet' recession of the kind Irving Fisher wrote about in the 1930s?

I have been feeling a strong urge to write about the economic policies of the former government of our resurrected prime minister, Kevin Rudd. Whenever I begin to write on this topic, however, what comes to mind is my grandmother’s advice that if you haven’t got anything nice to say, perhaps you shouldn’t say anything. It might be churlish of me to attempt to remind people that Kevin – whom so many people seem to revere as much now as in 2007 – has a record of achievement that is somewhat less than perfect.

Fortunately, not everyone has such qualms and some excellent articles about the economic policies of the Rudd government have appeared in the media over the last week or so. The best newspaper article I have read so far is one by Henry Ergas, entitled ‘Rudd’s Real Record’, published in The Australian last Saturday (July 13, 2013). Ergas reminds us, among other things, that in 2009 Rudd mounted a massive scare campaign about the severity of the GFC in an attempt to justify a splurge of poor quality government spending.

I recall how Janet Albrechtsen suggested in The Australian at the time that the GFC provided Rudd and his treasurer, Wayne Swan, with an opportunity that they were only too eager to grasp:

‘The Rudd Government finds itself at a very fortunate juncture. As Rudd’s treatise in the present edition of The Monthly reveals, he can blame capitalism for the coming government extravagance funded by taxpayers. Prepare for Rudd’s hubris-filled pitch on how he “saved” capitalism and why you had to pay for it.’

Whether we are prepared or not, we are now hearing Rudd’s hubris-filled pitch:

‘As you know, here in Australia, we deployed a national economic stimulus strategy, timely targeted and temporary, which helped keep Australia out of recession, kept the economy growing, and kept unemployment with a five in front of it – one of the lowest levels in the world.’

The hollowness of the claim by Rudd and Swan that the fiscal stimulus pulled Australia though the GFC has been demonstrated many times. For example, in an article entitled ‘Wayne Swan’s legacy of unrivalled incompetence’ in yesterday’s Financial Review (July 16, 2013), John Stone, former secretary to the Treasury, points out that the hubris of Rudd and Swan overlooks the strength of Australia’s fiscal position prior to the GFC, the role played by monetary policy, the underlying strength of Australia’s banks and the growth in China’s demand for our minerals.

John Stone’s article also raised the question I am intending to address here about balance sheet recessions. Stone suggests that the Australian Treasury had erred in seeing 2008-09 as another cyclical recession like that of 1991-92, rather than as a ‘balance sheet recession’ of the kind that Irving Fisher wrote about in an Econometrica article in 1933.

In my efforts to overcome my ignorance about the characteristics of a balance sheet recession I have managed to find an ungated copy of Irving Fisher’s article. Fisher suggested that in ‘great booms and depressions’ … ‘the big bad actors are debt disturbances and price level disturbances’, with other factors playing a subordinate role.

   

Fisher argued that it is the combination of over-indebtedness and price deflation that causes the depression:

‘When over-indebtedness stands alone, that is, does not lead to a fall of prices, in other words, when its tendency to do so is counteracted by inflationary forces (whether by accident or design), the resulting "cycle" will be far milder and far more regular.

Likewise, when a deflation occurs from other than debt causes and without any great volume of debt, the resulting evils are much less. It is the combination of both—the debt disease coming first, then precipitating the dollar disease—which works the greatest havoc.’

Fisher suggested:

 ‘it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged’.

That seems to me to be similar to the rationale for the quantitative easing policies adopted by central banks in recent years, following the failure of fiscal stimulus efforts. Lars Christensen, a market monetarist, has written more extensively about this similarity on his blog.

John Greenwood’s analysis, conducted in the spirit of Irving Fisher, suggests that some balance sheet repair has occurred in recent years in the countries most affected by the GFC, with greater progress having been made in the US than in the UK and least progress having occurred in the eurozone. 

Postscript:

An article by Max Walsh in today’s Financial Review (July 18, 2013), entitled ‘Rudd’s demands could exceed all expectations’, is another excellent article about the implications of the economic policies of the first Rudd government. Walsh refers to Rudd’s essay in The Monthly (February 2009) in which he sought to differentiate the economic ideology of the two major political parties in Australia. As might be expected, Rudd sought to portray his political opponents as extreme proponents of free market ideology, but he also portrayed the Labor party as being wedded to interventionism.

Kevin Rudd wrote: ‘Labor, in the international tradition of social democracy, consistently argues for a central role for government in the regulation of markets and the provision of public goods’. Max Walsh comments: ‘That’s a view that looks to be at odds with the deregulation and privatisation initiatives of the Hawke-Keating years’.

Viewed in that context, it seems to me that the most likely outcome of Kevin Rudd’s recent promise to pursue microeconomic reform ‘with new urgency’ will be further restriction of economic freedom and lower productivity growth. 

Do 19th Century principles of political economy explain British policies towards the Irish during the great famine?

This question has arisen from my reading of ‘The Great Famine’, by Ciarán Ó Murchadha. But I have an interest in the question for two additional reasons: I have some Irish ancestors who would have been affected by the great famine; and in the course of my work as an economist I have developed a great deal of respect for 19^th Century political economics.

I found Ó Muchadha’s book to be enlightening in explaining why a substantial proportion of the Irish population were heavily dependent on potatoes and highly vulnerable when crops were destroyed by a fungal disease in most of the years from 1845 to 1849. Prior to the famine, about one-third of the population was completely dependent on potatoes because no other crop could provide as much nutritional value from small plots of land. Over 600,000 households subsisted without tenure rights on small plots of land under the conacre system, which gave them access to land in exchange for their labour. A further 300, 000 cottier households had a more formal tenancy relationship which entailed working for set wages, which were offset against the rent for their plots. Many tenants on small holdings paid their rents in cash rather than by providing labour, but were also completely dependent on potatoes for subsistence. 

In the decades leading up to 1845, access to land for potato-growing was becoming more difficult, partly because of an increasing tendency for landowners to consolidate holdings for grazing purposes. In their struggle to obtain access to land it had apparently become common for poor people to offer more rent than they could possibly pay, in the hope that once possession was obtained it would be less bothersome for landlords to reduce rents than to initiate eviction proceedings. The transactions costs associated with evictions were often substantial. Tenants had a set of ‘tradition-sanctioned’ modes of proceeding under cover of darkness against people whom they believed to be perpetrators of injustice. 

Such secret society activity did not persist after 1847, however.  By that time, those who would have been likely to exact retribution for evictions were apparently ‘for the most part dead, in the workhouses, in prison or had departed overseas as emigrants or as transported felons’. The famine added impetus to the number of evictions, not just because many tenants were unable to pay rent, but also because landlords anticipated that their rates would rise dramatically to pay for relief under the Poor Law. Evictions would have substantially increased the death toll from the famine, but from a landlord’s perspective, consolidation of holdings was necessary in order to avoid bankruptcy.

The relief provided by voluntary contributions and the British government was not sufficient to prevent over a million deaths occurring during the famine period. The British Treasury spent about £8 million on famine relief in Ireland, much of which consisted of advances that were intended to be repaid. The government’s contribution was relatively small by comparison, for example, with the £69 million spent on the Crimean War of 1854-1856. The government could have done more to help the Irish without causing much hardship within Britain.

So, why didn’t the British government provide more help to the victims of the Irish famine? The explanation offered by the author is as follows:

‘Political economy … combined with ‘providentialist’ and ‘moralist’ views, provided the assumptions underlying the decision-making of the small London-based political elite whose views translated into legislation for Ireland, and none of whom ever witnessed its effects first hand’ (page 194).

However, that doesn’t line up well with what I know about the views of prominent 19^th Century political economists. For example, in discussing the limits of laissez faire in his book ‘Principles of Political Economy’, published in 1948, J S Mill wrote:

‘Apart from any metaphysical considerations respecting the foundation of morals or of the social union, it will be admitted to be right that human beings should help one another; and the more so, in proportion to the urgency of the need: and none needs help so urgently as one who is starving. The claim to help, therefore, created by destitution, is one of the strongest which can exist; and there is prima facie the amplest reason for making the relief of so extreme an exigency as certain to those who require it, as by any arrangements of society it can be made.’

Ciarán Ó Murchadha implies that his view is based on research by Peter Gray, which demonstrates

 ‘that the ideological framework was part of a wider set of beliefs shared across the British political spectrum, including the conviction that the Famine had been sent by providence, and that it furnished the British state with both the opportunity and the moral authority to reform Ireland thoroughly’.

A paper by Peter Gray has explained British policies towards the Irish in terms of

‘a readiness to attribute mass famine mortality in Ireland to the wilful immorality of the Irish, and to insist on the implementation of the penal mechanism of the poor law on all social classes’.

Immediately afterwards, Gray adds:

‘This, rather than any unthinking adherence to “laissez faire” is what informed the doctrine of “natural causes” in the latter stages of the Irish famine’ (IEHC 2006 Helsinki Session 123).

It seems to me that British views relating to providence and morality might have been advanced by English people to avoid acknowledging that they did not feel much sympathy for starving people in Ireland. In his book, ‘Why Ireland Starved’ (1983) Joel Mokyr suggests:

‘It is not unreasonable to surmise that had anything like the famine occurred in England or Wales, the British government would have overcome its theoretical scruples and would have come to the rescue of the starving at a much larger scale. Ireland was not considered part of the British community. Had it been, its income per capita may not have been much higher, perhaps, but mass starvation due to a subsistence crisis would have been averted …’ (p 292).

Even though Britain and Ireland were part of a political union, there are strong historical reasons why many British and Irish people did not see each other as members of the same community. There is evidence that British political economists, including J S Mill, shared the prejudices against the Irish of many other British people. But the principles of political economy espoused by 19^th Century political economists did not require the British government to allow large numbers of people to die during the Irish famine.