By Karl Arnold Belser
22 November 2014

I read the book review by Paul Krugman of The Shifts and the Shocks: What We've Learned - and Have Still to Learn - from the Financial Crisis by Martin Wolf called (why weren't Alarm Bells Ringing?) in the New York Review of Books. The review gives the most succinct summary that I have seen regarding the financial situation that has occurred in the beginning of the 21st century. Further it agrees with the empirical data I display in my blog postings. I want to repeat some of the important points Krugman makes in this blog post so that I remember what he said.

I rarely get to read articles by Martin Wolf because he writes for the Financial Times whose articles are behind a pay wall. Wolf is one of the most astute observers of financial happenings that I am aware of.

Regarding Paul Krugman, I initially was in the austerity camp as the way to deal with the 2008 financial crisis. In those days I strongly disagreed with Krugman who was a proponent of Keynsian Economics. I changed my mind, as the evolution of my  previous blog post show. I now believe that deficit spending to stimulate demand has worked, while the excess debt accumulated adjusts downward. It is now clear that Keynesian Economics has in fact helped the US economy recover.

First I want to give the Minsky Moment description from the review:

What Minsky added, however, was the notion that deflation as a result of excessive debt is fated to happen every once in a while, that periodic financial crises are a more or less unavoidable feature of capitalism. According to his “financial instability hypothesis,” eras of economic stability carry within themselves the seeds of their own down- fall. If there hasn’t been a financial crisis for many years, both borrowers and lenders will become complacent, underestimating the risks of high levels of debt. Leverage will rise, year after year. Inevitably, however, there will come a point when something goes wrong—a financial bubble bursts, a major financial institution fails, whatever—and people will start worrying about debt again. This is the “Minsky moment” (a term coined by Pimco’s McCulley), and it is followed by a nasty case of debt deflation that is very hard for policymakers to fight.


This, then, is the Standard Model of the crisis. A long period of relative economic stability fueled complacency in both the private and public sectors, leading to an unsustainable rise in debt. Meanwhile, free-market ideology blinded policymakers to the dangers of growing financial debt, as with the vast number of underfunded mortgages, and in fact led them to dismantle many of the protections we had. And there was, inevitably in retrospect, a day of reckoning, in which the bubble of complacency burst and the fragility of our financial system turned that bursting bubble into catastrophe.

Wolf, according to Krugman, favors more regulation as the type of change required to prevent future financial crises. Krugman realizes that Secular Stagnation has not been accounted for.

Emphasizing the need to reduce financial fragility makes sense if you believe that the legacy of past financial excess is the reason we’re in so much trouble now. But are we sure about that? Let me offer two reasons to be skeptical.

First, while the depression that overtook the Western world in 2008 clearly came after the collapse of a vast financial bubble, that doesn’t mean that the bubble caused the depression. Late in The Shifts and the Shocks Wolf mentions the reemergence of the “secular stagnation” hypothesis, most famously in the speeches and writing of Lawrence Summers (Lord Adair Turner independently made similar points, as did I). But I’m not sure whether readers will grasp the full implications. If the secular stagnationists are right, advanced economies now suffer from persistently inadequate demand, so that depression is their normal state, except when spending is supported by bubbles. If that’s true, bubbles aren’t the root of the problem; they’re actually a good thing while they last, because they prop up demand. Unfortunately, they’re not sustainable—so what we need urgently are policies to support demand on a continuing basis, which is an issue very different from questions of financial regulation.

I personally think that the world has entered into an era of very slow economic growth. The slow growth has happened because of declining resources, climate change excessive population and flawed public policy. I am pleased to see that Krugman is touching on these concerns.
Last updated November 22, 2014
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