Economics and complacency

There is a faith amongst some economists that growth will save us — but economists don’t have a good grasp of why economic growth does or does not take place — a fact that most of them will admit.  The current fad is to attribute growth to “institutions” — with the understanding that the specification of what institutions matter to growth, what institutions don’t matter and what institutions hinder growth has hardly been started (with the exception of the importance of property rights).

The foundation of the belief that growth will come seems to be the view that financial crises are just extreme versions of recessions and recessions are followed by recoveries.  This is an extremely ahistoric approach to economics since there are many examples of failed recoveries:  Holland in the late 18th c, Britain in the 1920s, Japan in the 90s.

This is probably related to the fact that most of the research on the Depression of the 30s takes the view that our ancestors made mistakes that we would never make.  Therefore, the outcome of our crisis has to be better than the outcome of their crisis.  However, as someone who has studied the 19th c approach to central banking, I suspect that we have made mistakes that our ancestors would never have made.

For example, about six years ago I corresponded with a researcher at a Federal Reserve Bank.  My question was this:  When tracking monetary data, why does the Fed report the “Non-financial commercial paper” series, but not the “Financial commercial paper” series?

The answer:  Financial commercial paper is used to make loans, so the assets and liabilities of the financial companies will zero out and have no effect on the money supply.

Think about that answer for moment.  The Fed’s policy was literally to ignore the increase in the liabilities of financial institutions because they did not affect measures of the money supply.  The Fed had a policy of ignoring credit growth on the part of financial institutions.  This is an error that 19th century bankers would never have made.  I suspect it grows out of the lazy habit of using Arrow Debreu based models where financial institutions don’t matter.

At the time I pointed out to the Fed researcher that the Fed should be keeping an eye on measures like financial commercial paper, because they were likely to be correlated with the risk of financial instability (and that I drew this conclusion from my knowledge of 19th c central banking).


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