“Like a good novel, each phase in economic history has its villains, heroes, and defining moments. Often, it is only with hindsight that we can identify them” (Borio and Whiter, August 2003).
At The inaugural conference of the Mosakowski Institute for Public Enterprise, Clark University which took place on November 13-14, 2008, The Honorable Michel Dukakis, former Governor of Massachusetts and currently a professor of Political Science, Northeastern University, gave Clark University President’ lecture: “Reality based Leadership: Putting ideas into action”. Given that the conference theme was “University Research and the American Agenda: Discovering Knowledge, Enabling Leadership”, it was more than befitting to gain insight about leadership from someone who held a leadership position as the governor of Massachusetts for three terms.
The talk was thought provoking to put mildly. Addressing an audience of students, faculty, and administrators as well as invited conference participants, governor Dukakis spent the better part of his speech talking about his administration accomplishments. And, while doing so he saw fit to chastise the “Academy” for its complacency in addressing national needs, social as well as economics. He described the Academy’s activities as given rise to “national failure” along the line one may ascribe to the market the concept of market failure associated with public sector provision of the public good. He forcefully pointed out that the learning experience at US colleges and Universities neither prepares students to participate in the public sector arena, nor instruct them about issues that affect theirs and their fellow citizens’ lives. He reserved his harshest critique for universities’ researchers in general and economists in particular.
Alluding to the
This harsh critique is well earned. One need not agree with governor Dukakis harsh critique of the Academy to acknowledge the academic failure in not making the contributions’ of its members heard, and heard not by fellow colleagues and students but by the community at large. If there is a failure, it is not a failure in teaching or research but rather in dissemination. But dissemination of finding outside the university gates is costly, both in time and money. Communications have benefits as well as costs, and the market for dissemination of information is imperfect to say the least (more on that in a follow up blog).As an economists among others in the audience, although not particularly welcoming Governor Dukakis harsh critique of the Academy (his full remarks are posted at the Mosakowiski Institute web page), I appreciated the concern eloquently expressed for the social needs of those who have fallen out of the “social net”.
Without touting one’s horn, I have always believed and acted upon the view that education must serve the public as well as the private interest. Throughout my academic career I have been fortunate enough to carry out this task, not only as a member of the Academy but also as a participant in research institutions whose function is to disseminate information to a wide audience as well as participate if not shape debates about the nation, economic policy. Institutions like the Brookings Institution, the American Enterprise Institute are most often identified as the Academy where public debates on issues originate and information about policy impact is disseminated. Researchers in these institutions are members of those colleges and universities for whom the governor directed his criticism. The fact that faculty members do not run to the State House or the halls of Congress to testify does not mean that they do not contribute to shaping public policy or inform their fellow citizens about the merits as well as the pitfalls of such policies. One should not loose sight of the fact that the ‘Academy’ is the store of value as well as the generator of these values. A look at who is who in the public sector, how policy is formulated, aired out and sometimes “killed” paint the full picture of the Academy. Indeed today there are more institutes that you can count on hands and feet compared to forty years ago. Institutes have replaced the Academy narrowly defined as referring to colleges and universities as the instrument for effective engagement in public policy debates. This development for the most part reflects the cost of dissemination of knowledge, both the time is required for the activities and the money needed to for effective delivery. The new Mosakowski Institute is an example as to why only at that level a member of a college and or a university can be heard, as it reduces the personal cost of participation.
With my partial response to Governor Dukakis critique out of the way, a bit of economics is in order. Putting the current crisis in historical perspective, one need not go further than the Nixon era. During Nixon’s tenure (1968- 1974), the phrase was coined “we are all Keynesian now”. Keynesian economics was named after John Maynard Keynes’s The General Theory of Employment, Interest and Money (1936). The Great Depression of the 1930’s convinced the majority of economists that the emphasis on the efficiency of “unfettered” markets is misplaced. Keynes argued that the source of economic fluctuations is aggregate demand and that active stabilization policy—government tax reductions and spending increases, are needed to stabilize the economy.
In the 1960’s, there was near consensus about Keynesian economics. This consensus however faltered in 1970’s with the emergence of the “New Classical Macroeconomics”. The New Classical economists argued for replacing Keynesian economics with “Macroeconomics” theory based on market efficiency, and that it should be grounded in microeconomics, that economic agents (you and I and our company)act in the economy in our best interest i.e. optimize.
The new Classical Macroeconomics was challenged and a new stream of developed by a school of thought referred to as the “New Keynesians. The major tenets of the new theory are: that fluctuations in nominal variables like money supply influence real variables like GDP and, that economic fluctuations are the product of market imperfections such as wage and price rigidities. Theoretical developments about sources of fluctuations, how policy monetary and fiscal affect the real economy, whether governments should pursue active policy (manipulating monetary aggregates and budget posture) or follow passive policy, like Milton Friedman fixed 3% monetary rule or John Taylor interest rate rule, and so on . The macro economics landscape had become so convoluted that most economists especially those teaching the undergraduate macro, unable to inject all these new developments (often highly mathematical) in the course materials to explain the phenomenon of economic fluctuations. Those of us who taught graduate macro had to run not only to catch up with developments in the field but also to figure out which side of the debate one has to declare oneself. Macro economics was comingled with monetary economics, high power modeling and empirical analysis. The central issue of fluctuations was debated and what to do about it depended on the model of the time. In short macro economics lost its innocence. We needed to know a lot more than we did during the phase of Keynesian macro economics.
What implications had these developments for the conduct of policy? Most significant perhaps, are the proliferations of innovations that had taken place in the financial markets some of which have barely been digested in the literature and or in policy debates. Ideology about the efficiency of the market still remained supreme; hence a laissez faire attitude prevailed at least among many in the economic profession. Today financial woes may in part reflect unshaken faith in the superiority of market outcomes. What went wrong is a complicated and lengthy scenario that would require as big a volume as the General Theory (I am confident that some economist will come up with an opus magnum on it like the one by Friedman and Schwartz: Monetary History of the
Since the mid 1990’s economists have written about changes in the macro economy, especially about changes in the monetary transmission mechanism and especially about financial innovations such as securitization, the rapid growth of derivative markets and financial liberalizations.(see Federal Reserve Bank of New York Conference on monetary transmission, April 5-6, 2001, also papers in the Federal Reserve Bank of Kansas City’s Symposium on Monetary policy and Uncertainty: Adapting to a changing Economy, August 28- 30, 2003) just to name a few. Several papers dealt with the impact of financial innovations on the real economy as well as the liberalizations on the financial sector in general and the banking sectors in particular. There were many warnings of about dangers ahead but went unheeded.
The paper by Borio and White “Whither Monetary and Financial Stability? The implications of Evolving Monetary Regimes” is of particular interest. The authors make the following points:
- Financial liberalization both within and across national borders which began in the mid 1970’s were virtually completed in 1990’s. For all intent and purposes, this produced a shift from a government-led to a market- led international financial system (p.140). The result is a rise in competitive pressures and easier access to external funding.
- Advances in information technologies led to a wider spectrum of tradable instruments, in particular the rapid development of derivatives markets facilitated by the unbundling of risk into its constituent components (p. 143).
- Increased focus of Central Banks on price stability. This shift implied a grater willing to accept volatility in short run interest rate.
Their conclusion in a nutshell is that: “changes in the financial and monetary regimes may have potentially increased the scope for financial imbalances to grow during expansionary phases. This makes the economy more vulnerable to boom and bust cycles (p.149). In a liberalized financial environment, the risk of episodes of financial instability is higher than in a more controlled system. The incidence of banking crisis was much more limited during the post war, a period where the financial system was much more regulated.
From the analysis they posit that: The policy challenge would be to put in place mutually supportive safeguards in the financial and monetary spheres to insure the necessary degree of financial and monetary stability.
With policy makers being hasty to rescue and bail out the financial sector and or the beleaguered auto industry, they should take a deep breath and see where their policies fit in light of the imposing changes in the financial structure and the transmission mechanism of monetary policy. They would do well to read Borio and White’s timely analysis.
One final note: Early on I have indicated that if there is a failure at the Academy it is in the transmission of the fruits of research. I believe this view is shared by many whose research is in the public interest yet it lacked public hearings. Good news on this front. A new publication in accessible format was launched October 2008: Economists Voice, www.bepress.com/ev. The objective is to make the economist’s views on current issues, events and policy heard in a format accessible to a wide audience I applaud this effort and hope that many members of the Academy follow suit.
[1] Friedman & Schwartz, A Monetary History of The
