Grasping Reality on TypePad, by Brad DeLong

Note to Self: I need to resolve this. I am profoundly dissatisfied with teaching the origin of business cycles and "general gluts" via John Stuart Mill's 1829 "excess demand for money is excess supply of everything else", and in an economy of sticky prices, wages, and debts produces the recessions and depressions that we all know and love so well. It is a quick way to get into the subject. It is a convincing way. But it is not a correct way. There are, however, two problems:

1. What is the "correct" way, exactly?
2. How can we teach something closer to the "correct" way than Mill's "excess demand for money is excess supply of everything else" without losing our audience?

In the meanwhile, think upon:

Daniel Kuehn: Whack-A-Mole General Gluts and Money: The interest rate is really one price functioning in two markets.... You can arbitrage your way out of whack-a-mole gluts. You cannot arbitrage your way out of an overdetermined system...

Nick Rowe: Walras' Law vs Monetary Disequilibrium: "Walras' Law says that a general glut (excess supply) of newly-produced goods (and services) has to be matched by an excess demand for... money... bonds; land; old masters; used furniture; unobtainium; whatever.... Monetary Disequilibrium Theory says that a general glut of newly-produced goods can only be matched by an excess demand for money. There's only one mole to whack. Money is special. A general glut is always and everywhere a monetary phenomenon...

Paul Krugman: There's Something About Macro: "Money as an ordinary good begs many questions: surely money plays a special sort of role.... [Plus] there is something not quite right about pretending that prices and interest rates are determined by a static equilibrium problem.... Finally, sticky prices play a crucial role... [but] the assumption of at least temporarily rigid nominal prices is one of those things that works beautifully in practice but very badly in theory...

And please tell me what to do instead of Mill (1829)!

I see this argument a bunch of places. Here it is from the sharp Felix Salmon. But I think it is wrong: Felix Salmon: Why the Fed Was Right to Hike: "When interest rates stay very low for an extended period of time, that has the effect of creating asset bubbles like the credit and housing boom of the mid-2000s.... If your stocks, bonds and real estate holdings were worth the same today, relative to GDP, that they were worth in 1995, they would have to crash in value by 33%, or $43 trillion. That's more than enough to trigger another financial crisis...

Note to Self: America's equities are worth 20% less than they were worth three months ago. Needless to say, the only change in fundamentals between then and now is... that now investors in the stock market are no longer as optimistic or risk tolerant. Risk-free rates going forward are the same. Expected future productivity levels are the same. The curvature of individuals' utility functions as their wealth increase is the same...

Let me hammer this point again: the failure of any of Barro, Bhagwati, Boskin, Calomiris, Cogan, Holtz-Eakin, Hubbard, Lazear, Lindsey, Mankiw, Rosen, Shultz, Taylor, and a hundred-odd others to write about—or even express curiosity about why—their confident predictions of a year ago that the Trump-McConnell-Ryan corporate tax cut would generate a huge investment boom—that silence speaks very loudly about the genre in which they viewed their forecasts back at the time:

A year ago there were a substantial number of economists who were assuring us that the Trump-McConnell-Ryan corporate tax cut was not just a giveaway to rich stockholders but would provide a sustained and substantial boost to investment in America that would boost productivity by:

• Barro, Boskin, Cogan, Holtz-Eakin, Hubbard, Lindsey, Rosen, Shultz, and Taylor said "3% to 4%... if achieved over a decade, the... increase in... annual... growth would be about 0.4%..."

• Hubbard, Lindsay, Holtz-Eakin, and a fourth (who is either Lazear or Mankiw) said, according to Sen Susan Collins (R-ME), by enough to raise tax collections enough to keep the deficit from going up by much.

• Miller, Calomiris, Bhagwati, and a hundred-odd others said by enough to raise tax collections enough to keep the deficit from going up at all—and boost annual growth by 0.4%.

• Barro, endorsed by Boskin, doubling down and claiming not 4% but 7% as the long-run boost to productivity and prosperity—and boost annual growth by 0.4%.

And Kevin Hassett and Greg Mankiw told us that these productivity gains would primarily boost wages not profits—because the relevant model was not one in which the tax cut raised after tax profit and interest rates but rather one in which foreigners would flood America with savings, lending to and investing in this country on a large scale to finance the bulk of this surge and investment.

It is not three Trump policies weighing on the stock market: it is four. Add to Barry's list: having your sole policy accomplishment be a tax cut tuned not to boost growth: Barry Ritholtz: Donald Trump Owns This Stock Market: "I assumed that Trump’s aggressive style, economic ignorance and personal peccadilloes wouldn’t leave a lasting mark on either stocks or bonds.... The chaos surrounding this presidency proves that was wishful thinking.... Consider three distinct policies of this administration, and how they are hurting the economy and markets.... Higher interest rates.... Powell’s leanings were well known...

Lend freely at a penalty rate on collateral that is good in normal times: David Warsh: What Have We Learned Since Bagehot?: "Fighting Financial Crises: Learning from the Past... by Gary Gorton and Ellis Tallman... offer five 'guiding principles' for dealing with financial crises in the future. Find the short-term debt.... Suppress bank-specific information... emergency lending facilities.... Prevent systemically important institutions from failing.... And consider that certain laws and regulations need not be applied during a financial crisis...

Chenzi Xu: Reshaping Global Trade: The Immediate and Long-Run Effects of Bank Failures: "The unexpected failure in May 1866 of Overend and Gurney, London’s largest interbank lender... led to widespread bank runs in London that caused 12 percent of British multinational banks to fail. These multinational banks played a dominant role in financing international trade during the 19th century...

I have enormous respect for Ken, but I think he is largely wrong here. In any dystopian or failed state, why would you want to accept RogoffCoin? or DeLongCoin? Or any of the other ICOs coming down the pike. Yes, there is a space for a blockchain-supported anonymous currency. But the currency that will be adopted will be one that has substantial backing from somewhere—either some large organization with real asset and payments that decides it want to use it (a "cameralist" valuation), or a central focal point (which BitCoin might hold). I can see BitCoin being worth a hundred dollars in the long run because having been first mover is a potential focal point. I can't see anything else having value in the long run. It is not "cryptocurrency coins" that are "lottery tickets that pay off in a dystopian future"; it is (maybe) BitCoin.

After all, the South Sea Company had detected a true market opportunity—there would be durable demand for standardized Gilts. But, as Ken says, "the private sector may innovate, but in due time the government regulates and appropriates": the profits were reaped not by the South Sea Company or any of its competitors but by the British Treasury.

In the meantime, of course, there are Greater Fools for Fools to sell to, and so folly has a chance of looking wise ex post: Kenneth Rogoff: Betting on Dystopia: "The right way to think about cryptocurrency coins is as lottery tickets that pay off in a dystopian future where they are used in rogue and failed states, or perhaps in countries where citizens have already lost all semblance of privacy. That means that cryptocurrencies are not entirely worthless...

2018-12-08

We begin with Adam Tooze laying out the issues:

Adam Tooze: Italy: How Does the E.U. Think This Is Going to End?: "Over the past 10 years, Italy’s gross domestic product per capita has fallen... unique among large advanced economies...

...More than 32 percent of Italy’s young people are unemployed. The gloom, disappointment and frustration are undeniable. For the commission to declare that this is a time for austerity flies in the face of a reality that for many Italians is closer to a personal and national emergency....

The two parties that make up the current Italian government, the League and the Five Star Movement, were elected in March to address this crisis. The League is xenophobic; Five Star is erratic and zany. But the economic programs on which they campaigned are hardly outlandish.... The Italian government’s budget forecasts are optimistic. But others, including the Bank of Italy and the Peterson Institute of International Economics, warn that Italy is caught in a trap: Anxieties about debt sustainability mean that any stimulus has the perverse effect of driving up interest rates, squeezing bank lending and reducing growth...

What would have to be the case for a stimulus to have this perverse effect—to actually manage to not boost the economy but rather squeeze bank lending and reduce growth?

Our Filing System: The Basic IS Framework

Back in the late 1990s Paul Krugman concluded that workings of the macroeconomy had changed: that we had started to see The Return of Depression Economics https://books.google.com/books?isbn=039304839X. He was right. This meant that the economic analytical tools that had been forged in order to understand the Great Depression of the 1930s had become the right place to start any analysis of what was going on in the business cycle. And so it has proven to be for the past twenty years,

Therefore we start with John Hick's 1937 IS-Equation, from his article "Mr. Keynes and the 'Classics': A Suggested Interpretation" https://tinyurl.com/20181208a-delong. The variable we place on the left-hand side is aggregate demand AD. The variable we place on the right-hand side is the long-term risky real interest rate r. In between are a large host of parameters drawn from the macroeconomy's behavioral relationships and from salient features of the macroeconomic environment and macroeconomic policy. We identity aggregate demand AD with national income and product Y, arguing that the inventory-adjustment mechanism will make the two equal at the macroeconomy's short-run sticky-price Keynesian equilibrium within a few quarters of a year.

Then we have not so much a model of the macroeconomy as a filing system for factors that we can and need to model, thus:

To simplify notation, we will typically use "$\Delta$" to stand for changes in economic quantities generated by shifts in the economic policy and in the economic environment, and we will drop terms that are zero.

Applying Our Filing System to Italy Today

For the problem of understanding Italy today, the pieces of this equation that matter are:

The change in national income and product ${\Delta}Y$ equals the change in aggregate demand ${\Delta}Y$ equals the sum of:

• the multiplier $\mu$ times the change in government purchases ${\Delta}G$
• the multiplier $\mu$ times the foreign propensity to purchase our exports $x_f$ times the change in exchange speculator optimism or pessimism about the long-run soundness of the currency ${\Delta}{\epsilon}_o$
• the multiplier $\mu$ times the foreign propensity to purchase our exports $x_f$ times the sensitivity of the exchange rate to interest rates ${\epsilon}_r$ times the change in the interest rate in the rest of the eurozone ${\Delta}r^f$
• the multiplier $\mu$ times the sum of the interest sensitivity of investment $I_r$ plus the product of the foreign propensity to purchase our exports $x_f$ and the sensitivity of the exchange rate to interest rates ${\epsilon}_r$ all times the change in the interest rate ${\Delta}r$

Now we need an extra equation: a country with a freely-floating exchange rate $\epsilon$:

the change in the exchange rate Δε is equal to the change in exchange speculator optimism or pessimism about the long-run soundness of the currency Δε_o minus the sensitivity of the exchange rate to interest rates ε_r all times the change in the interest rate Δr. But Italy does not have a freely-floating exchange rate: Italy is in the eurozone. So

$ {\Delta}{\epsilon} = 0 $

therefore:

And the rewritten relevant parts of the IS equation are:

$ {\Delta}Y = \mu{\Delta}G - \frac{{\mu}I_r}{\epsilon_r}\Delta\epsilon_o -{\mu}I_r{\Delta}r^f $

Thus the change ${\Delta}Y$ in national income and product that follows a fiscal expansion with higher government purchases ${\Delta}G$ will be positive as long as:

$ {\Delta}G > \frac{I_r}{\epsilon_r}\Delta\epsilon_o + I_r{\Delta}r^f $

The shift to more expansionary fiscal policy will indeed boost demand, production, and employment unless this equation fails to hold.

Conclusion

What conclusions can we draw from this equation?

First, we conclude that taking on unsustainable debt—or rather debt perceived as unsustainable—could indeed fail to boost demand, production, and employment if the reaction Δε_o to ΔG is too large. The natural thing, therefore, would be for the IMF and the European Union to step in with short-term support and guarantees to ensure that the market reaction Δε_o coupled with a longer-term structural adjustment program to guarantee that debt repayment will in fact take place.

Second, that the European Union—which controls Δr^f—could assist by switching to an easier money-tighter fiscal policy mix itself and so creating a negative value for Δr^f.

Why would the European Union want to assist in these ways? Well, it wants a prosperous Italy, doesn't it? And it wants an Italy that stays in the eurozone, doesn't it? why would the IMF want to assist in these ways? Well, that is its job, isn't it?

If the past ten years ought to have taught the Great and Good of Europe anything, it is that ensuring prosperity, growth, and high employmennt is job #1. Figuring out how to dot the financial i's and cross the financial t's is distinctly secondary. But, as Adam Tooze writes, instead the Great and Good of Europe seem to wish to "hold the line on debt and deficits" without offering anything "positive in exchange, such as a common European investment and growth strategy or a more cooperative approach to the refugee question". He calls this, with great understatement, "a high-risk and negative strategy".

I cannot see how anyone can disagree.

#highlighted #globalization #eurozone #monetarypolicy

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Adam Tooze: Italy: How Does the E.U. Think This Is Going to End?: "Over the past 10 years, Italy’s gross domestic product per capita has fallen... unique among large advanced economies.... More than 32 percent of Italy’s young people are unemployed. The gloom, disappointment and frustration are undeniable. For the commission to declare that this is a time for austerity flies in the face of a reality that for many Italians is closer to a personal and national emergency...

From a year ago. Not a transcript but much more what I wish I had said—that is, heavily edited and revised to increase clarity, decrease stupidity, and file a little bit of the ragged stream-of-consciousness rough edges off.

Nevertheless, holds up very nicely, no?

Needless to say, the backdrop here is not the view from the Berkeley Northgate TV studio:

but this is the view from the conference room in which I am holding pre-exam-week office hours:

Unfortunately, the view of the Golden Gate to the left of the frame is blocked by three tall pine trees that have no reason to live, and the peak of Mount Tamalpais is hidden by the salmon-and-white apartment building on the right.

People over the nexzt three months trying to decide between jobs at Berkeley and at universities with larger endowments take norte..

How Powell May Approach Regulation If Named Fed Chair: From 2017-11-01: Anchor: Do you think that's concerning or do you think it's refreshing that Powell comes from the private sector?

Anna Snider: Just Released: Interactive R-star Charts: "With the arrival of Bank President John Williams... we’re now running—and sharing the output of—models he helped develop to obtain estimates of the natural rate of interest, or r-star, for the United States and other advanced economies... the real interest rate that allows an economy to expand in line with its underlying potential while keeping inflation stable.... We’re providing quarterly estimates of r-star and related variables on our public website in downloadable Excel files plus the replication code and documentation for both the Laubach-Williams ('LW') and Holston-Laubach-Williams ('HLW/) models...

Barry Ritholtz: How to Use Behavioral Finance in Asset Management, Part III: "The ugly truth: there is an enormous contingency of players who do not have your best interests at heart... expert at pushing the hot buttons hard-wired into you that is part of your evolutionary inheritance.... This is why we try to teach how to think... [to] see through the bullshit machinery.... Beta vs Alpha: Beta is cheap and easy, Alpha is expensive and hard.... People who create alpha are exceedingly rare; people who can identify them in advance are rarer still. Why should any of us assume we are in either camp? Understanding this gives investors the greatest probability of succeeding...

As Paul Krugman says at every opportunity, if you knew nothing of macro after 1975—if you were just armed with sticky-price IS-LM—you would have done an excellent job at understanding the U.S. economy since 2008. I want to point out that this holds true for more than the past ten years: this holds true for the past thirty years as well:

Business Investment, Residential Construction, Government Purchases, Exports

All as Shares of Nominal Potential GDP

All as Percentage-Point Deviations from 2007QI Values...

Once again, the Trump administration does not have to be competent for its chaos-monkey nature to wind up doing enormous damage: Gabe Gutierrez and Annie Rose Ramos: Harley-Davidson workers stunned by plant closure after tax cut: "Tim Primeaux has worked at the Harley-Davidson plant in Kansas City, Missouri, for 17 years. He was sure he was going to retire from the company. That all changed when Harley-Davidson told its 800 employees in January that the plant will be closing next year. Operations will be shifted to the motorcycle manufacturer's facility in York, Pennsylvania...

Contra Tim Duy, The Lack of Federal Reserve Maneuvering Room Is Very Worrisome...

This, by the every sharp Tim Duy, strikes me as simply wrong: Contrary to what he says, the Fed has room to combat the next crisis only if the next crisis is not really a crisis, but only a small liquidity hiccup in the financial markets. Anything bigger, and the Federal Reserve will be helpless, and hapless.

Look at the track of the interest rate the Federal Reserve controls—the short safe nominal interest rate:

In the past third of a century, by my count the Federal Reserve has decided six times that it needs to reduce interest rates in order to raise asset prices and try to lift contractionary pressure off of the economy—that is, once every five and a half years. Call these: 1985, 1987, 1991, 1998, 2000, and 2007.

A short version of my review of Adam Tooze's excellent Crashed: How a Decade of Financial Crises Changed the World: No Longer Fresh at Project Syndicate: Blame the Economists?: Ever since the 2008 financial crash and subsequent Great Recession, economists have been pilloried for failing to foresee the crisis, and for not convincing policymakers of what needed to be done to address it. But the upheavals of the past decade were more a product of historical contingency than technocratic failure: BERKELEY—Now that we are witnessing what looks like the historic decline of the West, it is worth asking what role economists might have played in the disasters of the past decade. From the end of World War II until 2007, Western political leaders at least acted as if they were interested in achieving full employment, price stability, an acceptably fair distribution of income and wealth, and an open international order in which all countries would benefit from trade and finance. True, these goals were always in tension, such that we sometimes put growth incentives before income equality, and openness before the interests of specific workers or industries. Nevertheless, the general thrust of policymaking was toward all four objectives. Then came 2008, when everything changed. The goal of full employment dropped off Western leaders’ radar... Read MOAR at Project Syndicate

Dan Davies on financial fraud is certainly the most entertaining book on Economics I have read this year. Highly recommend itcold Chris Dillow: Review of Dan Davies: Lying for Money: "Squalid crude affairs committed mostly by inadequates. This is a message of Dan Davies’ history of fraud, Lying For Money.... Most frauds fall into a few simple types.... Setting up a fake company... pyramid schemes... control frauds, whereby someone abuses a position of trust... plain counterfeiters. My favourite was Alves dos Reis, who persuaded the printers of legitimate Portuguese banknotes to print even more of them.... All this is done with the wit and clarity of exposition for which we have long admired Dan. His footnotes are an especial delight, reminding me of William Donaldson. Dan has also a theory of fraud. 'The optimal level of fraud is unlikely to be zero' he says. If we were to take so many precautions to stop it, we would also strangle legitimate economic activity...

Note to Self Why isn't the first rule of Federal Reserve policy "thou shalt not come even close to inverting the yield curve!"?

#notetoself #monetarypolicy #finance

I believe that there are four issues in this Summers-Krugman-Rogoff-Blanchard et al.-DeLong internet discussion of three years ago:

1. As far as we economists are concerned, are our models analysis pumps, or are they merely filing systems to remind us of experiential wisdom? In other words: Are our models to be taken seriously when they lead us to a conclusion that the great and good believe is unserious?

2. Do economies with exorbitant privilege in which the key leveraged financial institutions have little foreign-currency debt need to fear banking and government solvency crises?

3. Can economies with exorbitant privilege in which the key leveraged financial institutions have little foreign-currency debt rely on their abilty to print their way to liquidity in an emergency and on market participants' recognition of that ability?

4. Can economists build models and conduct analyses assuming that business expectations are reasonable things, and will not push the economy to a position that is not close to a self-consistent near rational expectations equilibrium?

As near as I can see:

1. Larry Summers says: filing systems, yes, no, no.
2. Paul Krugman says: analysis pumps, no, yes, yes.
3. I say" both, no, yes, no.

I think I should, sometime over the past three years, have written a really good piece about these questions based on the ten items below. But I regret that I have not:

Thinking how to talk about Schumpeter's "Ricardian Vice" and the extremely peculiar boosting by economists formerly of note and reputation of the Trump corporate tax cut, and so revisiting this https://www.bradford-delong.com/2013/05/niall-ferguson-is-wrong-to-say-that-he-is-doubly-stupid-why-did-keynes-write-in-the-long-run-we-are-all-dead-weblogging.html:

Niall Ferguson:

An Open Letter to the Harvard Community: Last week I said something stupid about John Maynard Keynes.  Asked to comment on Keynes’ famous observation “In the long run we are all dead,” I suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay. This was doubly stupid. First, it is obvious that people who do not have children also care about future generations. Second, I had forgotten that Keynes’ wife Lydia miscarried.

Niall is wrong. His suggestion was not doubly stupid. There is more.

Niall speaks of Keynes's "In the long run we are all dead" as if it is a carpe diem argument--a "seize the day" argument, analogous to Marvell's "To His Coy Mistress" or Herrick's "To the Virgins"--and Ferguson sees his task as that of explaining why Keynes adopted this be-a-grasshopper-not-an-ant "party like we're gonna die young!" form of economics, or perhaps form of morality.

But that is not it at all.

John Maynard Keynes (1923): A Tract on Monetary Reform", pp. 80-82: "[T]he [Quantity] Theory [of Money] has often been expounded on the further assumption that a mere change in the quantity of the currency cannot affect k, r, and k',—that is to say, in mathematical parlance, that n is an independent variable in relation to these quantities. It would follow from this that an arbitrary doubling of n, since this in itself is assumed not to affect k, r, and k', must have the effect of raising p to double what it would have been otherwise. The Quantity Theory is often stated in this, or a similar, form...

Was the Great Recession More Damaging Than the Great Depression?: ...Your parents’—more likely your grandparents’—Great Depression opened with the then-biggest-ever stock market crash, continued with the largest-ever sustained decline in GDP, and ended with a near-decade of subnormal production and employment. Yet 11 years after the 1929 crash, national income per worker was 10 percent above its 1929 level. The next year, 12 years after, it was 28 percent above its 1929 level. The economy had fully recovered. And then came the boom of World War II, followed by the “thirty glorious years” of post-World War II prosperity. The Great Depression was a nightmare. But the economy then woke up—and it was not haunted thereafter.

Our “Great Recession” opened in 2007 with what appeared to be a containable financial crisis. The economy subsequently danced on a knife-edge of instability for a year. Then came the crash — in stock market values, employment and GDP. The experience of the Great Depression, however, gave policymakers the knowledge and running room to keep our depression-in-the-making an order of magnitude less severe than the Great Depression. That’s all true. But it’s not the whole story. The Great Recession has cast a very large shadow on America’s future prosperity. We are still haunted by it... Read MOAR at Project Syndicate

If you believe in the "plucking model", by which the economy when "plucked" into a state below normal employment by a negative shock then returns to normal, there is not strong reason to begin a recession watch until normal employment has resumed or has almost resumed. It has. So it is time to start a "what will cause the next recession?" watch. Tim Duy says: it will not be weakness in housing. I concur: the current weakness in housing is what the Federal Reserve wants to see, and is the intended effect of its raising interest rates—a little less employment in housing construction producing a little more room for higher employment in other sectors: Tim Duy: Decision Time: "Remember the recession calls in 2016 when manufacturing rolled over? The thinking was that every time industrial production falls by 2%, a recession followed, and this time would be no different. But it was different. Those calls did not play out because the shock was largely contained to that sector; recessions stems from shocks that hit the entire economy. And even if a recession could be boiled down to a single indicator, I would pick the yield curve over housing...

Fresh at Project Syndicate: Blame the Economists?: Ever since the 2008 financial crash and subsequent Great Recession, economists have been pilloried for failing to foresee the crisis, and for not convincing policymakers of what needed to be done to address it. But the upheavals of the past decade were more a product of historical contingency than technocratic failure: BERKELEY—Now that we are witnessing what looks like the historic decline of the West, it is worth asking what role economists might have played in the disasters of the past decade. From the end of World War II until 2007, Western political leaders at least acted as if they were interested in achieving full employment, price stability, an acceptably fair distribution of income and wealth, and an open international order in which all countries would benefit from trade and finance. True, these goals were always in tension, such that we sometimes put growth incentives before income equality, and openness before the interests of specific workers or industries. Nevertheless, the general thrust of policymaking was toward all four objectives. Then came 2008, when everything changed. The goal of full employment dropped off Western leaders’ radar... Read MOAR at Project Syndicate

#projectsyndicate #economicsgonewrong #economicsgoneright #monetarypolicy #finance #politicaleconomy

Ricardo J. Caballero: Risk-Centric Macroeconomics and Safe Asset Shortages in the Global Economy: An Illustration of Mechanisms and Policies: "In these notes I summarize my research on the topic of risk-centric global macroeconomics. Collectively, this research makes the case that a risk-markets dislocations perspective of macroeconomics provides a unified framework to think about the mechanisms behind several of the main economic imbalances, crises, and structural fragilities observed in recent decades in the global economy. This perspective sheds light on the kind of policies, especially unconventional ones, that are likely to help the world economy navigate this tumultuous environment...

As Published: Self-Fulfilling Financial Crises: Many mistaken assumptions about the 2008 financial crisis remain in circulation. As long as policymakers believe the crisis was rooted in the housing bubble rather than human psychology, another crisis will be inevitable. | My Earlier Draft: The 2008 financial crisis and subsequent recession left the Global North 10% poorer than it otherwise would have been, based on 2005 forecasts. For those hoping to understand this episode better, for a while now I have been recommending four very good books on and about the financial crisis of 2008 and what has followed—the catastrophes that have left the Global North 10% poorer now than we confidently forecasted back in 2005 that we would be today. They are:

1. Kindleberger's Manias, Panics, and Crashes https://books.google.com/books?isbn=0230365353,
2. Reinhart and Rogoff's This Time It's Different https://books.google.com/books?isbn=0691152640,
3. Martin Wolf's The Shifts and the Shocks https://books.google.com/books?isbn=1101608447, and
4. Barry Eichengreen's Hall of Mirrors https://books.google.com/books?isbn=0190621079.

Now I want to add on a fifth book: Nicola Gennaioli and Andrei Shleifer's A Crisis of Beliefs: Investor Psychology and Financial Fragility https://books.google.com/books?isbn=0691184925. (Full disclosure: Shleifer was my roommate in college and graduate school; to this day, I credit him more than anybody else with whatever positive skills or reputation as an economist I may have.)

Hoisted from the Archives (October 2008): The Wrong Financial Crisis: Catastrophic failures of risk management throughout the entire banking sector multiplied a relatively minor collapse in housing prices into a paralysis of the global finance system not seen since the Great Depression. To fix it, governments should embark on a coordinated fiscal and monetary expansion and a coordinated bank recapitalisation:

All of us from Lawrence Summers to John Taylor were expecting a very different financial crisis. We were expecting the ‘Balance of Financial Terror’ between Asia and America to collapse and produce chaos. We are not having that financial crisis. Instead we are having a very different financial crisis. Catastrophic failures of risk management throughout the entire banking sector caused a relatively minor collapse in housing prices to freeze up global finance to a degree that has not been seen since the Great Depression.

Next time I give a "general macro-finance" talk, I should give this one—updated, of course. But how much updating is needed>: “Unknown Unknowns”: High Public Debt Levels and Other Sources of Risk in Today’s Macroeconomic Environment (NEEDS REVISION) https://www.icloud.com/keynote/0_py01Y-ZrGddLKba8Rl2r9eQ

It's alternative title is: Confusion: High Public Debt Levels and Other Sources of Risk in Today’s Macroeconomic Environment:

THE MUST-READ OF MUST-READS on the links between behavioral finance and macro: John Maynard Keynes (1936): The State of Long-Term Expectation: The General Theory of Employment, Interest and Money: Chapter 12: "If I may be allowed to appropriate the term _speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase...

Per Kurowski: Self-Fulfilling Financial Crises: "The risk weighted capital requirements for banks guarantee: 1. Especially large exposures to what’s perceived as especially safe, against especially little capital, which dooms or bank system to especially severe crises. 2. Especially low exposures to what is perceived as risky, like loans to entrepreneurs and SMEs, which dooms our economy to weakness and not being able to reach its potential. And that has yet not even been discussed, much less learned http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html...

Alan Kirman is wise. Listen to him: Monday DeLong Smackdown: Alan Kirman: Self-Fulfilling Financial Crises: For the first time I feel moved to disagree with your assessment here Brad. The behavioral approach proposed by the authors suffers from the same disease as many that have been proposed earlier. It is the idea that one particular "bias" will help to understand and explain the causes and consequences of economic crises. This seems to me to be at odds with what really goes on. Already in 1900 Poincaré criticised Bachelier because he ignored the fact that people tend to behave like sheep. People do not simply receive their information independently and then act on it and in so doing reveal that information. Herd behaviour would suggest that people's beliefs change and are strongly influenced by those with whom they interact...

Nicola Gennaioli and Andrei Shleifer: Two Myths of the 2008 Meltdown: "The 2008 financial crisis was not the result only of moral hazard; nor was it unforeseeable. While too-big-to-fail banks believed–rightly, it turned out–that they would be bailed out, consumers, rating agencies, and policymakers all bet on housing as well, destabilizing the system.... Two misconceptions in the current retrospectives of the crisis. These misunderstandings may seem purely academic, but they are not. They have major consequences for the ability of policymakers to prevent future crises...

http://delong.typepad.com/the-digital-revolution-and-the-state--book-talk.pdf

Bill Janeway: Doing Capitalism in the Innovation Economy 2.0 https://books.google.com/books?isbn=1108471277: "The innovation economy begins with discovery and culminates in speculation. Over some 250 years, economic growth has been driven by successive processes of trial and error: upstream exercises in research and invention and downstream experiments in exploiting the new economic space opened by innovation...

...Drawing on his professional experiences, William H. Janeway provides an accessible pathway for readers to appreciate the dynamics of the innovation economy. He combines personal reflections from a career spanning forty years in venture capital, with the development of an original theory of the role of asset bubbles in financing technological innovation and of the role of the state in playing an enabling role in the innovation process. Today, with the state frozen as an economic actor and access to the public equity markets only open to a minority, the innovation economy is stalled; learning the lessons from this book will contribute to its renewal...