Rethinking macroeconomic theory before the next crisis
Marc Lavoie
Keywords: potential output; financial crisis; hysteresis; DSGE models
Published in print:Jan 2018Category:Research ArticleDOI:https://doi.org/10.4337/roke.2018.01.01Pages:1–21
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Misguided economics policies relying on an unrealistic macroeconomic theory that denied the possibility of a crisis are at the origins of the global financial crisis. The goal of the present paper is to recall how the end of the Great Moderation has been interpreted by the advocates of mainstream economics, and how they have questioned their own macroeconomic theories as a consequence of what happened during and after the financial crisis. There is thus a need to reconsider most aspects of mainstream theory. In particular, the crisis has once more demonstrated that potential output is influenced by aggregate demand – a phenomenon associated with hysteresis, which also questions concepts such as the natural rate of interest and crowding-out effects.
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1 INTRODUCTION
While many countries throughout the world have faced severe financial crises over the last decades, and while the Japanese stagnation and the 1997 Asian financial crisis did induce some additional interest for the introduction of banking and finance into macroeconomic theory, it is only with the advent of the US subprime financial crisis that macroeconomic and monetary theories put forward by mainstream economists have started to be questioned. Still, there are at least two views about the role played by economic theory in generating the global financial crisis, which, depending on one's opinion, can be ascertained as having started at any of the three following times: when real-estate prices in the US started to decline in the summer of 2006; when interbank money markets first froze in Europe during the summer of 2007; or when it was announced that the Lehman Brothers investment bank declared bankruptcy on the 15th of September 2008. If we take the earliest date, then we can say that the financial crisis and its aftermath have been going on for over a decade.
Heterodox authors were criticizing mainstream economic theory in all its incarnations long before the global financial crisis. My purpose in writing this paper is not to survey these heterodox criticisms, whose value has been reinforced with the advent of the crisis, nor to assess the impact of the crisis on the future of heterodox economics. 1 Rather, the goal of the present paper is to briefly recall how the end of the Great Moderation – this 15-year period of low inflation and low variance in real growth rates in the Western world – has been interpreted by the advocates of mainstream economics: this is mainly done in Section 2. The rest of the paper is devoted to a review of a number of key issues in macroeconomic theory, examining what seems to have been changed or been questioned as a consequence of what has happened during and after the financial crisis. As a result, Section 3 will be devoted to the concept of hysteresis, which seems to have been resurrected by mainstream economists. Section 4 will deal with a number of miscellaneous issues, in particular the shape of the aggregate demand curve and the lack of a relationship between interest rates and public debt or deficit ratios. I will conclude in Section 5 with broad brush-strokes about what ought to disappear and what might disappear from macroeconomic theory. Many others, such as Stiglitz (2011; 2015) and Mendoza Bellido (2013) have done an excellent job in pursuing this kind of exercise. Here I offer my idiosyncratic thoughts, starting with the reaction of economists to the crisis.
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Have we been here before? Phases of financialization within the twentieth century in the US
Apostolos Fasianos, Diego Guevara and Christos Pierros
Keywords: financialization; monetary regimes; speculation
Published in print:Jan 2018
Apostolos Fasianos, Diego Guevara and Christos Pierros
Keywords: financialization; monetary regimes; speculation
Published in print:Jan 2018
Category:Research Article
Pages:34–61
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This paper explores the process of financialization from a historical perspective during the course of the twentieth century. We identify four phases of financialization: the first from the 1900s to 1933 (early financialization), the second from 1933 to 1940 (transitory phase), the third between 1945 and 1973 (de-financialization), and the fourth period picks up from the early 1970s and leads to the Great Recession (complex financialization). Our findings indicate that the main features of the current phase of financialization were already in place in the first period. We closely examine institutions within these distinct financial regimes and focus on the relative size of the financial sector, the respective regulation regime of each period, the intensity of the shareholder value orientation, as well as the level of financial innovations implemented. Although financialization is a recent term, the process is far from novel. We conclude that its effects can be studied better with reference to economic history.
1 INTRODUCTION
When did financialization start? While there is much literature on the increasing dominance of finance in the United States after 1970, little work to date has attempted to investigate whether financialization was taking place earlier. Whereas few authors consider financialization as an evolutionary process that can be traced back to pre-capitalist societies, most analysts emphasize the neoliberal period beginning in the 1980s.
Financialization, as Sawyer (2013/2014) appropriately describes it, is a process that widely varies in form and intensity across time and space. Accordingly, by utilizing empirical and qualitative analytical tools coming from different schools of thought, we identify distinct phases of financialization during the twentieth century in the US. In particular, we examine the resemblance of financialization's characteristics in the early twentieth century with those of the contemporary period, questioning whether the current phase of financialization is a vaguely different repetition of its older counterpart, as observed, for example, in the early 1900s.
To carry out our task, we divide the sample period into four distinct regimes, marked by structural breaks in the institutional setting of the economy, which affected the functioning of the financial sector. The first period of early financialization lasts from the beginning of the twentieth century up until 1933, as the New Deal agreement brought significant changes in financial regulation and policy orientation. The second period (1933–1940) reflects the transitory phase of the economy that leads to the third period, the ‘Golden Age of Capitalist Development’ (1945–1973). The crisis of 1973 heralded the end of the Golden Age. Last, we apply Dumenil and Levy's (2011) definition of neoliberalism as ‘financialized capitalism’ to link the fourth period of complex financialization with 1974–2010.
We contribute to the relevant literature by exploring financialization from a historical perspective and pointing out different varieties of financialization throughout the twentieth century in the US. While most studies focus on a few criteria to establish evidence of financialization, we employ a plethora of empirical and qualitative indicators that allow us to formulate a synthetic argument for the pace and the form of financialization in each distinct regime. We argue that financialization, characterized by an increased role for the financial sector along with higher complexity across financial objectives and institutions, is merely the current phase of a historical process that has been unfolding since the dawn of the twentieth century. In our view, the early 1930s period presents a significant resemblance to the current phase of financialization.
Financialization is associated with financial booms and busts and has a negative impact on the real production of the economy, as it results in unemployment and highlights income inequalities. History shows that the degree of financialization is a policy variable. For instance, in the postwar period, policymakers implemented a range of policy instruments (such as full employment policies of a Keynesian flavor) and enforced a strong regulatory environment in order to restrict the uncontrolled explosion of finance. The implications of our findings could point towards policies that could reverse the destabilizing effects that financialization has on society.
The paper is organized as follows: Section 2 discusses theoretical contributions with respect to financialization; Section 3 looks at the data relating to the financialization process, focusing on the importance of the US financial sector; and Section 4 provides an analysis of the course of financialization throughout the twentieth century, paying close attention to the interaction between financial innovations and the regulatory environment, as well as to the degree of shareholder value orientation in the US economy. We also scrutinize the commitment of fiscal and monetary policies to full employment and low-inflation targeting and examine whether the economic system is prone to financial collapse. The penultimate section (Section 5) summarizes our findings, which formulate and support our argument, while the last section (Section 6) concludes.
Download PDF (554.4 KB)
This paper explores the process of financialization from a historical perspective during the course of the twentieth century. We identify four phases of financialization: the first from the 1900s to 1933 (early financialization), the second from 1933 to 1940 (transitory phase), the third between 1945 and 1973 (de-financialization), and the fourth period picks up from the early 1970s and leads to the Great Recession (complex financialization). Our findings indicate that the main features of the current phase of financialization were already in place in the first period. We closely examine institutions within these distinct financial regimes and focus on the relative size of the financial sector, the respective regulation regime of each period, the intensity of the shareholder value orientation, as well as the level of financial innovations implemented. Although financialization is a recent term, the process is far from novel. We conclude that its effects can be studied better with reference to economic history.
1 INTRODUCTION
When did financialization start? While there is much literature on the increasing dominance of finance in the United States after 1970, little work to date has attempted to investigate whether financialization was taking place earlier. Whereas few authors consider financialization as an evolutionary process that can be traced back to pre-capitalist societies, most analysts emphasize the neoliberal period beginning in the 1980s.
Financialization, as Sawyer (2013/2014) appropriately describes it, is a process that widely varies in form and intensity across time and space. Accordingly, by utilizing empirical and qualitative analytical tools coming from different schools of thought, we identify distinct phases of financialization during the twentieth century in the US. In particular, we examine the resemblance of financialization's characteristics in the early twentieth century with those of the contemporary period, questioning whether the current phase of financialization is a vaguely different repetition of its older counterpart, as observed, for example, in the early 1900s.
To carry out our task, we divide the sample period into four distinct regimes, marked by structural breaks in the institutional setting of the economy, which affected the functioning of the financial sector. The first period of early financialization lasts from the beginning of the twentieth century up until 1933, as the New Deal agreement brought significant changes in financial regulation and policy orientation. The second period (1933–1940) reflects the transitory phase of the economy that leads to the third period, the ‘Golden Age of Capitalist Development’ (1945–1973). The crisis of 1973 heralded the end of the Golden Age. Last, we apply Dumenil and Levy's (2011) definition of neoliberalism as ‘financialized capitalism’ to link the fourth period of complex financialization with 1974–2010.
We contribute to the relevant literature by exploring financialization from a historical perspective and pointing out different varieties of financialization throughout the twentieth century in the US. While most studies focus on a few criteria to establish evidence of financialization, we employ a plethora of empirical and qualitative indicators that allow us to formulate a synthetic argument for the pace and the form of financialization in each distinct regime. We argue that financialization, characterized by an increased role for the financial sector along with higher complexity across financial objectives and institutions, is merely the current phase of a historical process that has been unfolding since the dawn of the twentieth century. In our view, the early 1930s period presents a significant resemblance to the current phase of financialization.
Financialization is associated with financial booms and busts and has a negative impact on the real production of the economy, as it results in unemployment and highlights income inequalities. History shows that the degree of financialization is a policy variable. For instance, in the postwar period, policymakers implemented a range of policy instruments (such as full employment policies of a Keynesian flavor) and enforced a strong regulatory environment in order to restrict the uncontrolled explosion of finance. The implications of our findings could point towards policies that could reverse the destabilizing effects that financialization has on society.
The paper is organized as follows: Section 2 discusses theoretical contributions with respect to financialization; Section 3 looks at the data relating to the financialization process, focusing on the importance of the US financial sector; and Section 4 provides an analysis of the course of financialization throughout the twentieth century, paying close attention to the interaction between financial innovations and the regulatory environment, as well as to the degree of shareholder value orientation in the US economy. We also scrutinize the commitment of fiscal and monetary policies to full employment and low-inflation targeting and examine whether the economic system is prone to financial collapse. The penultimate section (Section 5) summarizes our findings, which formulate and support our argument, while the last section (Section 6) concludes.
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