Learning from the old masters of economics3 min read . Updated: 24 Dec 2015, 10:36 PM IST
A new, innovative and flawed thinking gathered strength after 1975
Economists who were banished from modern textbooks have made a stunning comeback ever since the global financial crisis undermined the credibility of the dominant consensus. The Reserve Bank of India has done well to note in the new Financial Stability Report released on Wednesday: “When current wisdom does not offer solutions to extant problems, old wisdom can sometimes be helpful." It should be seen as a call to reconnect with an earlier brand of economics that was drowned in the tidal wave of the new, innovative and flawed thinking that gathered strength after 1975.
The immediate aftermath of the financial crisis saw the spotlight turn back on three economists. The financial stability hypothesis of Hyman Minsky was accepted as a powerful way to examine business cycles. The deflationary cycle that threatened economies with excess leverage brought back memories of Irving Fisher. And the fiscal levers hurriedly reactivated by governments were a tribute to John Maynard Keynes. Minsky helped us understand why it happened, Fisher offered clues about how matters would become worse, while Keynes offered a way out of the mess.
There are a few other economists who also deserve attention in our times. The central bank rightly notes that the recent debates about secular stagnation have their roots in the work done by Alvin Hansen at the time of the Great Depression. The important distinction that Frank Knight drew between risk and uncertainty (the latter cannot be assigned a probability) is also important in a world that is increasingly aware of the disruptive effects of black swan events.
Finally, we would also like to add the powerful critique of the money supply process by the likes of Nicholas Kaldor, who said money is not created exogenously by the central bank but is the result of the lending activities of the commercial banks who loan money to companies, a view that the Bank of England seems to be now embracing.
These are not mere academic exercises. Ben Bernanke relied a great deal as the chairman of the Federal Reserve on wisdom acquired as an academic studying the Great Depression. His knowledge of economic history helped him negotiate the crisis.
In fact, Bernanke promised economist and Nobel laureate Milton Friedman on his 90th birthday in 2002 that the Fed will not repeat the mistakes it made during the Great Depression. Friedman and Anna Schwartz have shown in their work that the Fed did not take necessary steps during the Great Depression. “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again," said Bernanke.
The International Monetary Fund has already hosted a series of seminars on rethinking macroeconomic policy. This series was started by its former chief economist Olivier Blanchard who had announced, with terrible timing, a few months before the financial tsunami hit the real world, that all was well in the world of macroeconomics. It is also testimony to his intellectual honesty that Blanchard took the lead in pushing the multilateral lender to rethink its old dogmas about fiscal policy or capital account controls.
The Indian central bank also needs to get into the act. India has a long tradition of sophisticated thinking of issues of economic growth, money supply and inflation. Much of that is now forgotten though there are any number of veteran central bankers and monetary economists who participated in the heated debates during the 1970s, when inflation was out of control.
It is not our case that all that is old is gold. Or that every modern innovation in economic thinking needs to be junked. But being less dismissive of what the central bank has called the old wisdom would be welcome.
Has old wisdom in economics become more relevant after the financial crisis? Tell us at email@example.com