Saturday, November 7, 2009

How the crisis could change economic theory

Here's an interesting look at how the housing bubble may change macroeconomic theory.
The crisis exposed the inadequacy of economists' traditional tool kit, forcing them to revisit questions many had long thought answered, such as how to tame disruptive boom-and-bust cycles. ...

"We could be looking at a paradigm shift," says Frederic Mishkin, a former Federal Reserve governor now at Columbia University.

That shift could change the way central bankers do their job, possibly leading them to wade more deeply into markets. They could, for example, place greater emphasis on the amount of borrowing in the economy, rather than just the interest rates at which borrowing is done. In boom times, that could lead them to restrict how much money various players, ranging from hedge funds to home buyers, can borrow.


  1. I cannot bring myself to believe that policy makers will ever "restrict how much money various players, ranging from hedge funds to home buyers, can borrow."

    Yet, should such an idea actually find it's way into policy, we stand at the edge of the end to market instability.

    I am hopeful that by "how much money various players" they also mean how many individual can borrow.

    With every new opportunity to make money comes hundreds to thousands of new individuals and firms, far more than the long run will sustain. The market becomes flooded with players and the flood of production puts the latest improved chicken in every pot. Once the market demand has been satisfied, and everyone that needs the improved chicken has one, the demand crashes.

    Feedback in physics recognizes three fundamental responses, over damped, under damped and critically damped. The constant oscillation of business cycles is no less of an under damped response than seen in any other system.

    At some point these cycles of bust and boom have to be dampened out. At some point, the benefit from getting a dozen internet companies online asap is outweighed by the frustration of tens thousands of unemployed HTML programmers.

  2. For a different approach to preventing the boom-bust cycle, you might look for Mason Gaffney's brand new book, "After the Crash: Designing a Depression-Free Economy," available from the bookstore at See also two shorter pieces of his, linked from the front page of that same site: "The Great Crash of 2008," and "How to Thaw Credit, Now and Forever."