Macroeconomics

The purpose of the paper is to argue for attention to be paid, not only to choice of theory, but also to choice of theoretical approach, in order to address issues posed by the crisis.

Many people regard the recent financial crisis as a painful addition to an already massive body of evidence that demonstrates the inadequacy of today’s economic models of “rational” markets.

Eugene Fama, one of the founders of the so-called “Efficient Markets Hypothesis” (EMH), articulated early on the basic narrative that underpins it: “competition… among the many [rational] intelligent participants [would result in an] efficient market at any point in time [in which] the actual price of a security will be a good estimate of its intrinsic value” (Fama, 1965, p. 56).

As Carmen Reinhart and Kenneth Rogoff remind us in the title of their book, This Time is Different: Eight Centuries of Financial Folly, financial crises are nothing new (Reinhart and Rogoff (2009)). However, they often come as a surprise to many people because in most countries they appear only periodically.

The current economic and financial crisis, and it is both, has already imposed great costs on the global economy. Nor is there any guarantee that we have seen the worst and that recovery is now assured.

The world economy in 2008-2009 has passed through the most severe economic downturn since World War II. This global recession was preceded by the collapse of some of the largest financial institutions in the world.

Economic theory has modeled itself on theoretical physics. It has sought to establish timelessly valid laws that govern economic behavior and can be used reversibly both to explain and to predict events.

This is not intended to be a purely historical paper. I am interested in the light the Keynesian and Hayekian interpretations of the Great Depression throw on the causes of the Great Recession of 2007-9 and in the policy relevance of the two positions to the management of today’s globalizing economy.

Learn to read, understand, and evaluate professional discourse about the current operation of money markets at the level of the Financial Times.