Lecture 1, 9 January 2014 -Pre-crash orthodoxies
Students at Manchester University and elsewhere have been demanding to be taught ‘post-crash economics’. I want to start this set of six lectures with an account of pre-crash orthodoxies -the theories which underpinned economic policy till 2008; the orthodoxies students are still taught. In my next lecture I tell how the unforeseen crisis caused politicians and policy-makers to jettison these orthodoxies in saving the world from another great depression. In my third and fourth lectures I examine the monetary and fiscal confusion which has reigned in the last five years –the experiments with ‘unorthodox monetary policy’ and the austerity drive in fiscal policy –as policy makers sought a path to recovery. In my fifth lecture I look at the causes of the crisis from the standpoint of the world monetary system. Finally, I ask the question: what should post-crash economics be like? What guidance should economics offer the policy-maker to prevent further calamities of the kind we have just experienced? What should students of economics be taught? In this lecture I will consider only those bits of pre-crash orthodoxy relevant to policy making, with main emphasis being on UK developments. Theories of expectation formation played an overwhelming part in shaping the theory of macroeconomic policy; with changes in the way economists modelled expectations marking the different phases of theory. I will treat these in roughly chronological order, starting with the Keynesian theory. II.UNCERTAIN EXPECTATIONS
Keynesian macro theory dominated policy from roughly 1945-1975. The minimum doctrine -not in Keynes, but in accepted versions of Keynesian theory -to justify policy intervention to stabilise economies is: SLIDE 1
1. Uncertain expectations, particularly important for investment, leaving investment to depend on 'conventions' and 'animal spirits'. 2. Relative interest-inelasticity of investment.
3. a) sticky nominal wages (unexplained) and b) sticky nominal interest rates (explained by liquidity preference). ____
The first point suggested investment was subject to severe fluctuations; the last suggested there was a lack or weakness of spontaneous recovery mechanisms- ie the possibility of 'under-employment equilibrium'. This led to a prescription for macro-policy: to prevent or minimise fluctuations of investment demand. Point 2 in combination with 3b suggested primacy of fiscal over monetary policy for stabilization. SLIDE 2
'For Keynes, it was the tendency for the private sector, from time to time, to want to stop spending and to accumulate financial assets instead that lay behind the problems of slumps and unemployment. It could be checked by deficit spending'. (C.J. Allsopp and D. Mayes (1985), in D. Morris (ed.) “The Economic System in the UK”, 374) 'In the standard Keynesian economic model, when the economy is at less than full capacity, output is determined by demand; and the management of economic activity and hence employment is effected by managing demand'. (ibid, 370) ____
Mention in passing, that there was a theoretical and social radicalism in Keynes obliterated in the standard postwar Keynesian model. For example, he thought insufficient demand was chronic and would get worse; and that, in consequence, the longer term survival of a free enterprise system depended on the redistribution of wealth and income and the reduction in hours of work. I will return to these points in my last lecture. Demand- management
The government used fiscal policy (variations in taxes and spending) to maintain full employment, while keeping short term interest rates close to some 'normal' (or expected) level. Ie. monetary policy was largely bypassed as a tool of demand-management. The government forecast real GDP for the following year by forecasting year on movement of its expenditure components: consumption, fixed capital formation, stock...
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