Robert Skidelsky on Keynes again in the NY Times:
"Among the most astonishing statements to be made by any policymaker in recent years was
Alan Greenspan’s admission this autumn that the regime of deregulation he oversaw as chairman of the
Federal Reserve was based on a “flaw”: he had overestimated the ability of a free market to self-correct and had missed the self-destructive power of deregulated mortgage lending. The “whole intellectual edifice,” he said, “collapsed in the summer of last year.”
I have to admit that it is astonishing.
"What was this “intellectual edifice”? As so often with policymakers, you need to tease out their beliefs from their policies. Greenspan must have believed something like the “efficient-market hypothesis,” which holds that financial markets always price assets correctly. Given that markets are efficient, they would need only the lightest regulation. Government officials who control the money supply have only one task — to keep prices roughly stable."
It is very important to understand, or tease out, beliefs from policies. For me, this is the difference between Politics and Political Theory and Political Economy and Economics. I don't believe markets are efficient. I do believe that the Fed's main function is to keep prices roughly stable, with a bias towards slight inflation.
"I don’t suppose that Greenspan actually bought this story literally, since experience of repeated financial crises too obviously contradicted it. It was, after all, only a model. But he must have believed something sufficiently like it to have supported extensive financial deregulation and to have kept interest rates low in the period when the housing bubble was growing. This was the intellectual edifice, of both theory and policy, which has just been blown sky high. As
George Soros rightly pointed out, “The salient feature of the current
financial crisis is that it was not caused by some external shock like
OPEC raising the price of oil. . . . The crisis was generated by the financial system itself.”
This is not very clear. I don't see a lot of explanatory power here. Is the decline in housing prices like the price of oil? Is the tsunami of foreclosures like OPEC or is it part of the financial system itself? I also don't credit the power of low interests rates as the most important cause of the current crisis. Deregulation might have had a part in this drama as well, but I need a little more explanation of what that part entails.
"This is where the great economist
John Maynard Keynes (1883-1946) comes in. Today, Keynes is justly enjoying a comeback. For the same “intellectual edifice” that Greenspan said has now collapsed was what supported the laissez-faire policies Keynes quarreled with in his times. Then, as now, economists believed that all uncertainty could be reduced to measurable risk. So asset prices always reflected fundamentals, and unregulated markets would in general be very stable."
So Laissez-Faire Policies entail believing that:
1) All uncertainty can be reduced to measurable risk ( Don't agree )
2) Asset prices always reflect fundamentals ( Don't agree. This involves perception and interpretation )
3) Unregulated markets are generally stable ( We don't have an unregulated market. I could say something banal and pronounce that well-regulated markets are stable. I guess that I just did, for all the lack of specificity and essentially tautological reasoning good it does me )
What's with the focus on Greenspan? Is this going to all be about Central Banks?
"By contrast, Keynes created an economics whose starting point was that not all future events could be reduced to measurable risk. There was a residue of genuine uncertainty, and this made disaster an ever-present possibility, not a once-in-a-lifetime “shock.” Investment was more an act of faith than a scientific calculation of probabilities. And in this fact lay the possibility of huge systemic mistakes."
I agree with Keynes here. Strangely, I thought that Hayek agreed with this.
"The basic question Keynes asked was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing. The chief of these are the assumptions that the future will be like the past (witness all the financial models that assumed housing prices wouldn’t fall) and that current prices correctly sum up “future prospects.” Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.” (Today, you might add a further convention — the belief that mathematics can conjure certainty out of uncertainty.)"
I should say that I'm a big fan of his writing style, which favorably disposes me to him. I would say:
1) People fall back on Narratives
2) That the future follows from the past must in some sense be true, since day follows from night. I thought that Keynes believed that it was very hard to predict the future in various situations, not all situations. In other words, some events are easier to predict than others.
3) I would say that we are part of a society. Run with the crowd is too Mechanistic for my taste.
4) Math cannot conjure certainty from uncertainty, if I understand what he means.
"But any view of the future based on what Keynes called “so flimsy a foundation” is liable to “sudden and violent changes” when the news changes. Investors do not process new information efficiently because they don’t know which information is relevant. Conventional behavior easily turns into herd behavior. Financial markets are punctuated by alternating currents of euphoria and panic."
This all adds up to people aren't omniscient. I don't think that all markets are euphoric then panicked, then euphoric and then panicked, and I certainly don't believe that this is inevitable. If I did, then that would go a long way towards predicting it.
"Keynes’s prescriptions were guided by his conception of money, which plays a disturbing role in his economics. Most economists have seen money simply as a means of payment, an improvement on barter. Keynes emphasized its role as a “store of value.” Why, he asked, should anyone outside a lunatic asylum wish to “hold” money? The answer he gave was that “holding” money was a way of postponing transactions. The “desire to hold money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. . . . The possession of actual money lulls our disquietude; and the premium we require to make us part with money is a measure of the degree of our disquietude.” The same reliance on “conventional” thinking that leads investors to spend profligately at certain times leads them to be highly cautious at others. Even a relatively weak dollar may, at moments of high uncertainty, seem more “secure” than any other asset, as we are currently seeing."
I'm a bit disturbed by this paragraph. I save money in order to have it in case I need it in the future for some unseen event. I find living in general disquieting, money much less so.
"It is this flight into cash that makes interest-rate policy such an uncertain agent of recovery. If the managers of banks and companies hold pessimistic views about the future, they will raise the price they charge for “giving up liquidity,” even though the central bank might be flooding the economy with cash. That is why Keynes did not think that cutting the central bank’s interest rate would necessarily — and certainly not quickly — lower the interest rates charged on different types of loans. This was his main argument for the use of government stimulus to fight a depression. There was only one sure way to get an increase in spending in the face of an extreme private-sector reluctance to spend, and that was for the government to spend the money itself. Spend on pyramids, spend on hospitals, but spend it must."
I call this a fear and aversion to risk and the accompanying flight to safety. I get the point, which is why I believe that a stimulus is worth a shot, after trying lowering interest rates. Is this supposed to be controversial?
"This, in a nutshell, was Keynes’s economics. His purpose, as he saw it, was not to destroy capitalism but to save it from itself. He thought that the work of rescue had to start with economic theory itself. Now that Greenspan’s intellectual edifice has collapsed, the moment has come to build a new structure on the foundations that Keynes laid."
That's basically my purpose. I believe that theories are of limited value, even Keynes' theories. I must not be in Greenspan's camp since I don't find any of this puzzling. As for Keynes, as I've said before, his theories will, in fact, end up being of limited worth as to specifics. We are looking to Keynes as a part of our Narrative that helps us deal with the present. It happens that the policies we're throwing at this crisis resemble Keynes enough that we are conjuring up his ghost to help us deal with it. That's fine. That's how we deal with crises. But we are essentially embarked on a trial and error ride that is more pragmatic than ideological, which is how it should be. It seems to me that what I've just stated is very Keynsian, if by that cognomen is meant one who uses what's truly valuable in Keynes' thought.
Posts
http://blogs.ft.com/economistsforum/2008/11/the-case-for-negative-interest-rates-now/#more-259
"The central bank and government, by devising a system in which such negativity can express itself, can give a big fillip to the recovery process.
The most direct channel for this fillip most likely passes through the equity market.
Pervasive negative risk-free rates across the advanced economies would underpin equity market levels.
Investors faced with certain substantial nominal loss on risk-free holdings would bid up the price of equity which could offer rich risk premiums even at a presently feebly level of prospective earnings.
And it is equity market developments which hold the key to the economic recovery."
And Martin Wolf's reply:
"Martin Wolf: This is ingenious and would, no doubt, permit negative real interest rates. But I would prefer it if vigorous action were taken by the monetary authorities to sustain inflation, before deflation set it, in which case we would never need negative nominal interest rates in order to obtain negative real rates.
If it is already too late for this, I agree that this scheme would make it possible for the authorities to impose negative real short rates. Another justification for negative real rates is that it would reduce the danger of debt deflation - the rising real level of debt as the price level falls. It would be wildly unpopular, of course, among politically powerful savers. It would have to be pointed out that this loss is offset by the rising real value of nominal claims.
But would it work in the way Brendan suggests? I am not sure. Equity markets might rise a little. But I very much doubt whether companies would start to issue equity in order to invest in a substantial way, in the midst of a deep recession. The underlying logic is Hayekian. I have never been convinced of this theory of the credit cycle.
So is there an alternative? Yes. The central bank can lend directly to the government, which can spend on investment and public consumption or make transfers to consumers to spend. If real interest rates were negative, this would be even cheaper for the government. That would certainly add to the effectiveness of such a policy, in any case."
From my perspective, Brown is correct, as Negative Interest Rates would be a disincentive to buy bonds, and an incentive to buy stocks for the longer term. QE that leads to very low interests rates now and higher interest rates in the future, as is happening now, should have the same effect. Why? You should invest in stocks when bond yields are low, and switch when bond yields are high. There are good reasons for the current rise in stock prices, although I have no idea if it is too much and too fast.