Friday, October 31, 2008

David Warsh on the Bail Outs

David Warsh, author of Economic Principals, a weekly on-line news commentary on what economists have done and are doing about issues, big or small, and of the most promising specialist research subjects, plus deep background to the interface between economic research and practical, at least in their intentions, policies.

His recent on-line contribution contains this interesting piece about the source of current attempts by governments to revive stagnant banking systems:

What Just Happened?

The emergency continues, a little less desperate than before. A remedy that works – direct government investment in threatened institutions in exchange for equity – seems to have been settled on in most industrial democracies.

A number of mysteries remain. For instance:

How deep has been the opposition between the Federal Reserve Board and the US Treasury Department these last fifteen months? Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson have presented a generally united front. But what goes on behind the scenes? What of their staffs? The sheer opacity of Paulson’s initial plan to buy and hold troubled securities, and the clumsiness with which it was presented, has yet to be explained. What was the process by which it was developed and internally reviewed?

And where did the ultimately successful plan come from, anyway? Ten days ago it appeared that it was UK Prime Minister Gordon Brown’s idea. True enough, Brown boldly and confidently tackled his banking crisis at its root. A cartoon in the Financial Times depicted leaders of other industrial nations following him along in a cheerful dance. There followed the standard paeans to John Maynard Keyes.

But the basic blueprints Brown adopted had been drawn up in Stockholm in late 1992, when central bankers in Sweden, Norway and Finland moved swiftly to rescue their big banks after the collapse of a property bubble. The rescue succeeded, though its aftermath lingered on for four years.

What were the channels through which Swedish influence flowed to London and Washington? This is an especially interesting question because of the experience of the early 1930s, when Gustav Cassel argued without success that overly restrictive American monetary policy was making matters worse, and Gunnar Myrdal devised budgetary policies implemented by the new Social Democratic government in 1933 that spared Sweden the worst of the Great Depression.

In other words, economists of the Stockholm School implemented successful macroeconomic policies several years before John Maynard Keynes published his General Theory of Employment, Interest and Money in 1936, even if they were unable to make the case for what they were doing to the wider world

Worth some thought, given that the media is searching for the guilty perpetrators of the current problems and for those culpable who were party to the disregard of warnings about their ‘spend-now-borrow-and-tax-later' policies. Come to think of it, the UK government is in effect continuing with the same policies that worsened the outcomes of what they conveniently call a 'global' crisis, an one partly of their own making.

David Warsh wrote the influential, Knowledge and the Wealth of Nations: A Story of Economic Discovery (W W Norton & Co Ltd, 2007). For a news review, see HERE, and for David’s own statement about his book, see HERE.

I claim no affinity in today’s topic to Lost Legacy’s main interests in Adam Smith’s moral philosophy and political economy but I strongly recommend that readers try a sample of Economic Principals (details HERE).

I started reading Economic Principals after I read Warsh’s book Knowledge and the Wealth of Nations, the title of which caught my attention, of course.

While I had qualms about Warsh’s repetition of the Chicago version of Adam Smith (reported on Lost Legacy at the time), he re-ignited my curiosity with his account of Paul Romer’s revival of increasing returns in respect of neoclassical growth theory (I have long since my student days been sceptical of Harrod-Domer's 'kife-edge' and Solow’s exogenous dead-end theories of growth).

From which re-reading, howwer, I was drawn to Allyn Young’s 1928 Economic Journal seminal article, ‘Increasing returns and economic progress’ (it’s online via google) and to the rehabilitation of Adam Smith’s growth theory in the context of the real importance of the division of labour (not the ‘pins’!) (discussed in my Adam Smith: a moral philosopher and his political economy, 2008, Palgrave Macmillian).

What might Economic Principals do for your research and interest in economics?

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