Prepare yourself for the next Policy Debate (it’s Going to be Tougher than Ever Before)

Read here Stiglitz’s view of the current financial meltdown: banks failed to estimate correctly the risk behind the recent financial innovations and central bankers got it wrong because they were reactive instead of being proactive (Stiglitz directly incriminates the FED, Greenspan, Basle II…).

Are financial innovations really the problem? Financial innovations enable a better management of the risk associated with mortgages and other financial transactions. This has been a constant drive in the West since the emergence of modern insurance in Holland in the 16th and 17th century. So I am not sure why recent financial innovations that enable to securitize debt would not constitute progress in the management of financial risk. In the current institutional environment, however, they may. Experience will tell.

Stiglitz is correct in saying that there is so much banks (and financial innovators) can do to mitigate central bankers’ poor job—particularly as the latter can be a source of systemic uncertainty. By virtue of their monopolistic role (and the absence of commodity money and reserves), central bankers are bound to get it wrong—especially when confronted to new situations. In the absence of market mechanisms, consistently guessing the evolution of the demand for money (M1, M2, and M3) is impossible.

But this does not mean, as Stiglitz concludes, that because central bankers often react poorly we need them to take a much more proactive stance (i.e. issue more regulations—Basle III perhaps?). Stiglitz uses the current situation to indict the free market one more time:

This is the third US crisis in the past 20 years, after the Savings & Loan crisis of 1989 and the Enron/WorldCom crisis in 2002. Deregulation has not worked. Unfettered markets may produce big bonuses for CEOs, but they do not lead, as if by an invisible hand, to societal well-being. Until we achieve a better balance between markets and government, the world will continue to pay a high price.

This type of view is gathering momentum all around the world: “We tried “unfettered” markets and it failed, so it’s time to go back to regulation.” I am not sure how prepared Austrian economists and others are to respond. This is all because pro-free market ideas lost the battle of implementation and this loss could very well be a fatal blow. The lack of full implementation of pro-market policies in the past may now backfire and the diagnostic will be that we need more regulation of (financial) markets, not less. We are on the slippery slope again. Central bankers cannot get it right and economic recessions will, from time to time, come around. The problem will be to engage those who see pro-free market policies as a failure of the last two decades and the reason behind central bankers’ mistakes. This is the next policy battle and it’s going to be tough.

Thanks to Ed Weick for the pointer.

Comments

[John V]

Wonderful! not.

Then perhaps the GMU crew and fellow travelers should start writing less about "terribly interesting" yet meaningless things like markets in everything and get down to business by addressing Stiglitzes and Krugmans of the world in a forceful, clear and methodical manner.

Bastiat was but one man. We have many more now and they should be working a little harder.

[Grant]

Although I don't know much about the quality of his economics, why would anyone take Stiglitz's policy recommendations seriously? He seems to totally ignore criticism from the public choice and Austrian schools (ironic, given how much he's written about Hayek) on the limitations of government.

Stiglitz doesn't seem to be anything new to me. Whenever I read him, I get the same feeling: "Markets aren't perfect, but the ideal government economists can build in their head is. Therefore, we need more government." Normally I'd ask people like that why, if the political process works so well, wasn't government able to stop the problem before it got bad? But that wouldn't be fruitful, because people like Stiglitz seem to refuse to see politics as a process with its own problems, instead preferring to think of it as something which can become whatever they can dream in their minds.

[Rafe Champion]

It is a worry when a person with a three digit IQ and tertiary education is still talking about unfettered markets, as if we are standing in them! Like the people who think we had unfettered markets in the 1920s and 30s (don't mention the tariff wars).

If you are feeling masochistic, check out the Amazon US reviews of Naomi Kline's latest book. A typical example http://www.amazon.com/review/R3AEODOK6WS6SX/ref=cm_cr_rdp_perm

[dg lesvic]

Here was my take on Stiglitz, a while back:

What won't they think of next? Prof. Joseph Stiglitz was just awarded a Nobel Prize for the startling revelation that the market isn’t perfect. Perhaps they’ll give me one too for pointing out that socialism isn’t quite perfect either.

However revolutionary his thinking, a real revolution in economics, the “marginal revolution” of over a hundred years ago has passed him by. He has “observed” higher taxes on the rich having “no adverse effect.” For he saw what happened above but not at the margin of profitability, where all change occurs, the jobs created, in spite of the higher taxes, but not those that failed to emerge, because of them. That was hidden from a Nobel Prize winning, empirical and mathematical “economist.” For economics is not an empirical and mathematical but theoretical and logical science.

The Atlantic Monthly, of Oct. 2002, described Stiglitz as a "moderate liberal economist" accepting "the basic premises of the free market, with certain limitations."

But he has denied its most basic premise, the Invisible Hand. For that was simply a metaphor for all the invisible causal relations of economics; and, denial of it, of all such relations, economics, and, ultimately, human action itself.

He says that he is a tough grader on economic policy. So am I. And if a student may grade the teacher, his demand-side, cart before the horse economics, exploded hundreds of years ago by analogy with that of the foolish inn-keeper, giving away money to be spent in his inn, will get failing marks.

Speaking of social justice, rather than of what works and doesn’t work, he is a political propagandist, not an economist.

[Vedran]

John V,

I had article a little while back attacking Stiglitz. It's not on this topic but it does try to go after his character a bit which is never a bad thing when a person is wrong on a number of topics

Here's the link http://www.mises.org/story/2266

[Carlos]

Here is the answer to Stiglitz: http://mjperry.blogspot.com/2008/02/real-scandal-how-feds-invited-mortgage.html

So much for the supposed "unfettered markets"

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