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A Note on Competing Economic Theories on the 2007-2008+ financial Crisis: the Case for (Hidden) Stagflation

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A Note on Competing Economic Theories on the 2007-2008+ financial Crisis: the Case for (Hidden) Stagflation Munich Personal RePEc Archive A note on competing economic theories on the 2007-2008+ financial crisis: The case for (hidden) stagflation Colignatus, Thomas Thomas Cool Consultancy Econometrics 29 September 2008 Online at https://mpra.ub.uni-muenchen.de/10831/ MPRA Paper No. 10831, posted 30 Sep 2008 02:06 UTC A note on competing economic theories on the 2007-2008+ financial crisis: The case for (hidden) stagflation September 29 2008 by Thomas Colignatus http://www.dataweb.nl/~ ool Abstract The finan ial risis that erupted in 2007, ontinues in 2008 and likely ontinues longer, is in need for explanation by e onomi theory. The monetary authorities and finan ial regulators provide us with pie emeal engineering on the fly but there is a la k of overview. The la k of onvin ing theory and strategy be omes espe ially worrying when we see the risis affe ting the real e onomy. People and e onomi a tivities that already suffer are not well-represented in national statisti s, whi h provides newspapers with a rosy pi ture as if the urrent risis only affe ts the finan ial se tor and not the real e onomy. )hen the risis starts to bite those who are in the statisti s then the finan ial risis will be ome re ognized for the e onomi risis that it is, but apparently with little guidan e from e onomi theory on how to solve it. The time honoured solution is to have the poor and powerless work harder and earn less to solve the problems of the ri h and powerful. But e onomi theory an do better. The paper ompares various ompeting e onomi theories and suggests that e onomists study a parti ular theory that apparently hasn,t had suffi ient attention yet. The urrent finan ial risis finds a fundamental ause in stagflation. This stagflation originally was open but was later hidden by finan ial deregulation and innovation. By ta kling stagflation the finan ial risis would be ome manageable. A suggestion on how to ta kle stagflation is provided by Colignatus .20050, 12efinition 3 Reality in the 5eneral Theory of Politi al E onomy7, 2ut h 8niversity Press 9eywords: finan ial risis, e onomi risis, stagflation, inflation, unemployment, Phillips urve, taxes Introduction The urrent finan ial risis gives a wide range of issues and problems, see e.g. The E onomist .20080 and Leijonhufvud .20080. Though we use the at h-all phrase 1the finan ial risis7, it may be doubted indeed whether there is only a single issue and it may well be that there are more overlapping issues. It may also be doubted whether the present author has mu h to say on these various issues - who ould do so with some onvin ing power would be rather ri h and learly this is not the ase, see M Closkey .19900. Yet the urrent finan ial risis is important and some points an be indi ated. Moreover, this paper will larify that this is not only a finan ial rises but rather an e onomi risis, relevant for the whole e onomy. Even though the situation may be ompared to a puzzle and even though all pie es in a puzzle are relevant, so that we an hardly say that one and only one pie e is of prime importan e, it still makes sense to observe that ommon expositions on the finan ial risis leave out one key pie e. Clearly, a puzzle is more puzzling if a .key0 pie e is missing. 1 The main point in this paper is that there are ompeting e onomi theories for the urrent finan ial risis. This risis provides a test on existing theories and allows us to identify whi h theories are relevant and whi h are not. The proposition here is that the prime ause behind the urrent finan ial risis is stagflation, as has already argued by Colignatus .1990, 1992, 1994 and 20050. My earlier analysis learly did not get the attention that it deserved. By onsequen e the world e onomy has been managed by relying on erroneous theories and thus I am not surprised that the urrent e onomy is a bit in disarray. The wrong poli ies for a while aused that stagflation be ame hidden, but now it is oming into the open again. It is an interesting question how mu h more disarray the world e onomy will have to suffer before my fellow e onomists give up their misguided ideas and take time to study a more proper alternative. 2avid Aendry .s. would require me to produ e models, data series and e onometri tests. I refer to Colignatus op. it. for a 1definition 3 reality methodology7 that answers to that hallenge. I do want to draw attention to Pollo k and Letta .20010 who dis uss the ausation between in ome and onsumption, whi h dire tion of ausation is quite relevant now. If we don,t keep up expenditure then our in ome will suffer. These two remarks satisfy our urrent need for number run hing e onometri s. For the remainder of the paper it suffi es to use logi only. Readers interested in logi are referred to my book on logi , Colignatus .20070 and the review by 5ill .20080. Competing theories The main theory, that an be alled Theory A, is given in Colignatus .1990, 1992, 1994 and 20050. The 2005 book is the most a essible and suffi iently omprehensive for urrent purposes. In a nutshell the story is this. Erroneous theories and poli ies on the labour market, taxation and so ial insuran e aused the stagflationary shift of the Phillips urve, with per olation to all wages and the whole e onomy. Fis al and monetary authorities didn,t and still don,t see this and adhere to other theories. Some poli ies are reated on the fly as new ir umstan es of the day reate new needs. To battle unemployment and inflation the authorities have allowed laxer monetary and finan ial standards, and they have let themselves to be guided by ideas on deregulation and new finan ial instruments. Those events have hidden stagflation for a while. A onsequen e is that the finan ial se tor has been inflated with money. Currently there are no reliable measures of liquidity or 1how mu h money7 is in the system but we an be sure that this has in reased enormously. )rong theories and poli ies have reated their own monster and it will take strong nerves to ontrol it. Cbviously, all this has to be seen against the ba kdrop of important hanges in the real e onomy, su h as the rise of the emerging markets, the ICT revolution, population growth, the environmental problem and new s ar ity, the Iraq war and su h. In e onomi s there are few mono- ausal experiments. An important element in the finan ial risis is that the Chinese government propped up the dollar, apparently in order to keep up exports to the 8S. The lower 8S rate of interest propelled the sto k market and mortgages. The key point here is that, apparently, the Chinese government had no good poli y for inland e onomi development and that the 8S government had no good alternative for import substitution and keeping inflation low. This an be explained as a negle t of Theory A. A prime alternative, that an be alled Theory B, is that the urrent finan ial problem is only a problem for the finan ial se tor. Indeed, some might argue that the risis is smaller sin e some instruments have allowed some hedges against worse developments. Aowever, urrent developments orre tly ause us to restore various regulations. Theory B would hold that this would be enough. If we restore regulations su h as on distin tions between savings banks, investment banks and insuran e ompanies, on bonus systems, new finan ial produ ts, and su h, then things would be C9 again D at least that is this theory. This approa h has the benefit that it a epts that the finan ial se tor is no longer the best example of Erationality, and 2 Eeffi ien y,. Yet, this Theory B still denies the linkages between the monetary / finan ial se tor and the 1real7 e onomy. It is advisable indeed that various deregulations are reversed and that the finan ial se tor is re-regulated again. Aowever, when the hands of the monetary authorities are tied again, as they used to be, and they no longer have this other way out of de-regulation and finan ial innovation, then it is quite likely that stagflation will show up into the lear again. )e may even hold as a riterion of su ess of re-regulation that stagflation omes into the open again. This on lusion is onsistent with Leijonhufvud .20080: 1The likely prospe t for the 8nited States in any ase is a period of stagflation. The issue is going to be how mu h inflation and how mu h unemployment and stagnation are we going to have.7 From this it follows that Theory B an be reje ted: this is not just a risis for the monetary and finan ial se tor. 2eregulation has not been limited to the finan ial se tor but has been applied to the whole e onomy. Theory C is that overall deregulation and more unequal distribution of in ome, with e.g.
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