It’s of course a great privilege for me to be here in this role and especially on the occasion of the 75th anniversary of the publication of the General Theory.
Two years ago, as you may recall, our profession enjoyed a moment of ferment. Economists who had built their careers on inflation targeting, rational expectations, representative agents, the efficient markets hypothesis, dynamic stochastic general equilibrium models, the virtues of deregulation and privatization and the Great Moderation were forced by events momentarily to shut up. The fact that they had been absurdly, conspicuously and even in some cases admittedly wrong imposed even a little humility on a few. One senior American legal policy intellectual, a fellow traveler of the Chicago School, announced his conversion to Keynesianism as though it were news.
The apogee of this moment was the publication in the New York Times Sunday Magazine of Paul Krugman’s essay, How The Economists Got It So Wrong. And in it, I noticed, Krugman admitted, and I’ll quote, that:
And I must say, looking out on this audience, it would be fair to say that there were more than just a few and it’s a pleasure to be here among you.… a few economists challenged the assumption of rational behavior, questioned the belief that financial markets can be trusted and pointed to the long history of financial crises that had devastating economic consequences. But they were swimming against the tide, unable to make much headway against a pervasive and, in retrospect, foolish complacency.
In keeping with mainstream practice, Krugman named almost nobody. So, in a reply essay entitled, Who Were Those Economists, Anyway?, I described the neglected, ignored and denied second and third generation work largely, though not entirely, in the tradition of Keynes which did get it right. I could have named many more than I did including many in this room.
Let me begin therefore here by distinguishing between the three major lines of Keynesian thought that did in fact get it right—that had bearing and application on the events through which we have just passed. And I will honor the well remembered and beloved by identifying these lines with Wynne Godley, Hyman Minsky and Galbraith père.
Godley, of course, worked in the Keynes, Kuznets, Kalecki, Kaldor tradition of macroeconomic models attentive to national income accounting identities and to consistency between stocks and flows. The virtue of this approach is clarity and a comparative lack of overreaching ambition. Models of this type say nothing false which may not seem like much, but it’s a huge advantage over the starting position in mainstream economics which consists of nothing which is true. And the models direct you to check whether factual claims make sense given everything that they may imply.
Thus, that the federal surpluses in the United States’ budget in the late 1990′s implied unsustainable private debts was clear to those working in this tradition at the time. Just as, the fact that household debt burdens were again unsustainable was clear in the 2000′s. Again, perhaps it seems like not much, because it is simply an argument rooted in the national income accounts, until you remember that policy in a country like the United States is very strongly influenced by the macroeconomic forecasting of institutions like the Congressional Budget Office which impose no such consistency constraints on their models and do not check to see whether forecasts in one area imply reasonable and plausible outcomes in another. For this reason, much of that work is essentially nonsense.
Hyman Minsky developed an economics of financial instability, of instability bred by stability itself, the intrinsic consequence of overconfidence mixed with ambition and greed. Minsky’s approach, very different from Godley’s, is conceptual rather than statistical. A key virtue is that it puts finance at the center of economic analysis, analytically inseparable from what is sometimes called real economic activity, for the simple reason that capitalistic economies are run by banks. And, of course, his second great insight is into the dynamics of phase transitions: the famous movement from the hedge position to the speculative position to the intrinsically unsustainable, doomed to collapse ponzi position which arises from within the system and is subject actually to formalization in the endogenous instabilities of non-linear dynamical models.
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