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The Great Debate©: Who Saw it Coming?

by John Lounsbury

This edition of The Great Debate© is prompted by an essay from Brad DeLong today (30 June 2012) and a rebuttal from Steve Keen.  Before we present those two protagonists we will return to a paper published by Dutch economist Dirk Bezemer in 2009.  That paper was reviewed by this author when it appeared and an update of that review in 2010  is presented here as the first leg of this debate.  DeLong and Keen follow in that order.

Note: The caption photo was taken of the winner after a previous Great Debate©.  Click on photo for larger image.

Twelve Who Forecast the Financial Crisis

by John Lounsbury, Global Economic Intersection

A research paper entitled “No One Saw this Crisis Coming”, published in June 2009 by Dirk J. Bezemer, Groningen University, addresses the question of who actually did foresee the financial crisis of 2008.  He says the answer is that many saw it coming but those with the power to act did nothing. Bezemer contends the problem is that economic policy is executed using macro equilibrium models and what is needed to establish economic policy that can anticipate crises, such as we have now, and take actions to head them off, are macro accounting cash-flow models. The entire paper can be read here.

First, let me show you a table that Bezemer has prepared lisiting some of those who saw it coming. Table is in two parts for graphics processing reasons.

click to enlarge images

In a lengthy appendix, Bezemer analyses in detail what each of the 12 individuals did over extended periods of time to highlight the then incipient crisis.

Bezemer says that those who foresaw the coming crisis share the general characteristic that they viewed the economy through an accounting models lens. He wrote,

They are ‘accounting’ models in the sense that they represent households’, firms’ and governments’ balance sheets and their interrelations. If society’s wealth and debt levels reflected in balance sheets are among the determinants of its growth sustainability and its financial stability, such models are likely to timely signal threats of instability.

Models that do not – such as the general equilibrium models widely used in academic and CentralBank analysis – are prone to ‘Type II errors’ of false negatives – rejecting the possibility of crisis when in reality it is just months ahead. Moreover, if balance sheets matter to the economy’s macroperformance, then the development of micro-level accounting rules and practices are integral to understanding broader economic development.

This view shows any clear dividing line between‘economics’ and ‘accounting’ to be artificial, and on the contrary implies a role for an ‘accounting of economics’ research field. Thus this paper aims to encourage accountants to bring their professional expertise to what is traditionally seen as the domain of economists – the assessment of financial stability and forecasting of the business cycle.”

The following graph is how Bezemer defines the general structure of accounting models.

He describes the functioning processes in this model as follows:

The finance, insurance and real estate (FIRE) sector includes all sorts of wealth-managing non-bank firms (pension funds, insurers, money managers, merchant banks, real estate agents etc.), as well as deposit-taking banks, which generate credit flows. It is conceptually separate from the real sector which comprises government, firms and households.

Liquidity from the FIRE sector flows to firms,households and the government as they borrow. It facilitates fixed-capital investment, productionand consumption, the value of which – by accounting necessity – is jointly equal to real-sector income in the form of profit, wages and taxes plus financial investment and obligations (principally, interest payments). Funds so originate in the banking part of the FIRE sector and either circulate in the real economy, or they return to the FIRE sector as financial investments or in payment of debt service and financial fees. Total credit flows (in nominal currency units) are normally increasing year on year, reflecting positive profit and interest rates.

Problems arise when the funds that originate in the banking part of the FIRE sector return to the FIRE sector in the form of investments or payment of debt service to the exclusion of circulation in the real economy. These problems can lead to recessionary economic collapse (although soft landings are possible), and, in the most severe dislocations, depressions. (Note: The last sentence contains my summary, not one that I found expressly stated by Bezemer in those exact terms.)  Read the entire article ….

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The Perils of Prophecy

by Brad DeLong, Project Syndicate

We economists who are steeped in economic and financial history – and aware of the history of economic thought concerning financial crises and their effects – have reason to be proud of our analyses over the past five years. We understood where we were heading, because we knew where we had been.

In particular, we understood that the rapid run-up of house prices, coupled with the extension of leverage, posed macroeconomic dangers. We recognized that large bubble-driven losses in assets held by leveraged financial institutions would cause a panicked flight to safety, and that preventing a deep depression required active official intervention as a lender of last resort.

Indeed, we understood that monetarist cures were likely to prove insufficient; that sovereigns need to guarantee each others’ solvency; and that withdrawing support too soon implied enormous dangers. We knew that premature attempts to achieve long-term fiscal balance would worsen the short-term crisis – and thus be counterproductive in the long-run. And we understood that we faced the threat of a jobless recovery, owing to cyclical factors, rather than to structural changes.

On all of these issues, historically-minded economists were right. Those who said that there would be no downturn, or that recovery would be rapid, or that the economy’s real problems were structural, or that supporting the economy would produce inflation (or high short-term interest rates), or that immediate fiscal austerity would be expansionary were wrong. Not just a little wrong. Completely wrong.  Read the entire article at Project Syndicate….

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What utter self-serving drivel, Brad DeLong!

by Steve Keen, Steve Keen’s Debt Watch

I can scarcely believe what Brad DeLong has dared to publish on Project Syndicate today:

We economists who are steeped in economic and financial history – and aware of the history of economic thought concerning financial crises and their effects – have reason to be proud of our analyses over the past five years. We understood where we were heading, because we knew where we had been.

In particular, we understood that the rapid run-up of house prices, coupled with the extension of leverage, posed macroeconomic dangers. We recognized that large bubble-driven losses in assets held by leveraged financial institutions would cause a panicked flight to safety, and that preventing a deep depression required active official intervention as a lender of last resort….

So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.

What utter hubris and drivel!

Where to begin? For starters, “the last five years” includes June 2007–just before the commencement of the financial crisis. But this time, people like Wynne Godley, Ann Pettifors, Randall Wray, Nouriel Roubini, Dean Baker, Peter Schiff and I had spent years warning that a huge crisis was coming, and had a variety of debt-based explanations as to why it was inevitable.  By then, Godley, Wray and I and many other Post Keynesian economists had spent decades imbibing and developing the work of Hyman Minsky.

To my knowledge, of DeLong’s motley crew, only Raghuram Rajan was in print with any warnings of an imminent crisis before it began. Blanchard deserves to win an award for one of the world’s worst-timed papers when in August 12, 2008–one year after the crisis began–he published a working paper which crowed that “the state of macro is good“.  Krugman, who DeLong crowns as first amongst equals in those working “in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger” first read Minsky in May 2009–and noted that he didn’t really see what all the fuss was about:

So I’m actually reading Hyman Minsky’s magnum opus, here in Seoul. … I have to say that the Platonic ideal of Minsky is a lot better than the reality.

There’s a deep insight in there; both the concept of financial fragility and his insight, way ahead of anyone else, that as the memory of the Depression faded the system was in fact becoming more fragile. But that insight takes up part of Chapter 9. The rest is a long slog through turgid writing, Kaleckian income distribution theory (which I don’t think has anything to do with the fundamental point), and more.

To be fair, it took me several decades before I learned to appreciate Keynes in the original. Maybe a reread will make me see the depths of Minsky’s insight across the board. Or maybe not.

This was hardly amazing to those of us who had started to read Minsky a bit earlier than 2009–such as me for example (I first read Minsky’s real magnum opus, John Maynard Keynes, in 1987). Those of us with a bit more exposure to Minsky knew that Stabilizing an Unstable Economy was not Minsky’s best book–and I commented on Krugman’s blog that he should put it aside and read Can “It” Happen Again? when he got back from Seoul.

The only excuse for the cant DeLong has spewed forth today is that, as with Krugman and others in the self-described “New Keynesian” camp, he perceives himself as being at the left end of the economic spectrum, with the only competition being from the far right represented by the purist Chicago version of Neoclassical economics. Since the Neoclassical left supports deficit spending during a Depression, while the right supports austerity, to DeLong it’s game over, and the Neoclassical left is right.

The reality is that there is an entire other dimension of economists who have known for decades that both extremes of the Neoclassical economic axis were neither left nor right, but plain bloody wrong. We also knew that our criticisms of the Neoclassicals had no chance of being listened to by the public until a major crisis hit, and we also expected that this crisis would do nothing to alter their own beliefs. DeLong’s delusional mutterings today confirm it.

I sometimes get accused of being harsh when I argue that economics will only progress from the delusion of Neoclassical economics into a more empirically based and realistic discipline the way that Max Planck observed that physics made the move from Maxwell to Einstein: “one funeral at a time“. I doubt that I’ll cop that criticism any more after Brad’s effort today.

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Editor’s note: Read the comments at Steve Keen’s Debt Watch which include further exchanges between DeLong and Keen.

Related Articles

The Great Debate©:  Keen and Krugman on Money and Banking

A Primer on Minsky by Steve Keen

Two Views of Money:  Keen and Krugman by Dirk Ehnts

Is Adam Smith Partly an Economist, or Wholly a Moral Philosopher? by Brad DeLong

About the Authors


delong Brad DeLong is professor of economics at U.C. Berkeley, chair of the Political Economy of Industrial Societies major, and a research associate of the National Bureau of Economic Research. Full bio.  He blogs at delong.typepad.com.


Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney, and author of the popular book Debunking Economics (Zed Books UK, 2001;www.debunkingeconomics.com).

Steve predicted the financial crisis as long ago as December 2005, and warned that back in 1995 that a period of apparent stability could merely be “the calm before the storm”. His leading role as one of the tiny minority of economists to both foresee the crisis and warn of it was recognised by his peers when he received the Revere Award from the Real World Economics Review for being the economist who most cogently warned of the crisis, and whose work is most likely to prevent future crises.

He has over 50 academic publications on topics as diverse as financial instability, the money creation process, mathematical flaws in the conventional model of supply and demand, flaws in Marxian economics, the application of physics to economics, Islamic finance, and the role of chaos and complexity theory in economics. His work has been translated into Chinese, German and Russian.


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