The Economic Crisis and the Crisis in Economics

modern economic theoryIn the fall of 2008 very few people – if any – had an idea of what was to happen in the financial market a few months later, if you are to believe the interview based “Too Big to Fail” by Sorkin (2009). A lot of things have followed the collapse of Lehman Brothers in September 2008. One of the issues discussed heavily hereafter both in the general public as within the field of Economics and Finance is how to handle bank resolution regimes and how to prevent future crisis through these on a micro level. On the other hand site there has been an increasing focus on the macro aspects as well – especially on macroprudential policies in recent years. The macro aspect covers as well the new role of the central banks as the change in their standard tools. According to Mathai (2011), among others, the new approaches taking in by the Central Banks can be undermining the neutrality between markets and governments.

Not only has the role of the central banks changed. With the financial crisis movements within economics that questions some of the basic assumptions, which for years now have been sacred have risen. This page will cover some of the repercussions here from.

The Economic Crisis and the Crisis in Economics

Recently I was by a coincidence introduced to The Institute of New Economic Thinking (INET) and in connection to this the INET Center for Imperfect Knowledge Economics. In the following I’ve summed up some of my findings on the work of the institute, which is definitely worth looking further into.

Purpose of the INET

In the fall of 2009, 25 economists met at, what was later referred to as, the Bedford Summit, where the foundation for the INET was made. The primary conclusion from this was that there should be made changes in the economic paradigm, since the field of economics in many cases no longer reflects the real world.

The Crisis in Economics: Rethinking the assumptions

the invisible handIn the spring of 2010, 200 economists discussed “The Economic Crisis and the Crisis in Economics” at Cambridge University as the first plenary of the INET. As Keynes in his time went after the prevailing paradigm in economics the INET gathered at Kings College to go after the prevailing paradigm of our time. As Stiglitz said in his speech during the plenary “(…) among those who have to take blame for the crisis is the economics profession. There are several aspects of the behavioral economy that seem so patently inconsistent with any model of rationality (…) that it is tempting to construct a model predicating rationality that explains such behavior”. As for the problems with the market Soros is of the belief that “(…) the misconception was the belief that markets correct their own excesses.” Akerlof follows this path as he says “It is true that capitalism does work, but unfortunately capitalism sometimes works all too well, and then it also has to be curbed.”

The Economic Crisis: International Political Economy

Optimal Currency AreaOne year later in the spring of 2011, 400 economists met for discussing “Crisis and Renewal: International Political Economy at the Crossroads” at the second plenary in Bretton Woods, New Hampshire. One of the issues discussed here was the “Optimal Currency Areas and Governance: The Challenge of Europe”. The discussion was, as the title suggests, based on the theory of Optimal Currency Areas (OCA) as it was founded by Mundell in 1961 (see article). A majority of American economists have, according to Frankel, been concerned with the Eurozone’s ability to comply with the requirements necessary for a common currency to be optimal according to the OCA theory as of Mundell (1961). According to Thygesen the necessity of the OCA requirements to be met before introducing the common currency has become subjacent, since when a common currency first has been introduced, the requirements might be met afterwards (see article). Anyhow Frankel in his speech on the second plenary in Bretton Woods stated four problems with the Eurozone as a OCA. Firstly it was a mistake to admit Greece into the Euro in the first place. Secondly in his view it was a mistake for the ECB to accept Greek bonds as collateral and he elaborates that this might have been the reason why investors charged spreads for Greek debt that was almost zero. Hereby Greece could borrow at basically the same interest rate as Germany. Thirdly he believes that it was misguided not sending of Greece to the IMF already in the beginning of the 2010. Finally that it was a mistake not wanting to think about restructuring the debt earlier.

Of course there has been a lot of water under the bridge since then. Nevertheless having the discussion as of how the economic theories where used or misused before the crisis especially within central banking, is certainly an interesting debate. On the 29-30th of January 2013 the Danish Institute for International Studies will be throwing a seminar on central banking at crossroads, which hopefully go more thoroughly into this.

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