[OPE] Martin Wolf on Keynes (again)

The Bank of England lowered its bank interest rate by 1.5 percentage points to 3.0%. The previous change in rates was a reduction of 0.5 percentage points to 4.5% on 8 October 2008. The ECB reduced key interest rates further by 50 basis points or 0.5%. Previously I jotted something about Mr Wolf's Keynesianism, from which I'll post an excerpt - Mr Wolf now admits that:

Keynes would be horrified that the world has let the genie of free capital flows out of the bottle. This, he would note, is why more external financing is needed than ever before, why vast foreign currency reserves have been accumulated and why financial crises are once again global, rather than local. He would add that "a sound banker, alas, is not one who foresees danger and avoids it, but one who, when he's ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him" [this is from JM Keynes, "Consequences to the Banks of a Collapse in Money Values", 1931 - JB]. We have far too many such bankers. He would surely add that these undercapitalised and illiquid institutions are little short of financial time-bombs. Yet can anything useful be done to meet such challenges? It is certainly possible - and indeed necessary - to change the global architecture, not least in response to changing economic weights. It is equally necessary to give the IMF more financial resources in support of its new short-term lending facility. But it is surely too optimistic to believe that the Fund would ever be able to provide reliable warnings of looming crises. Even if it did, it is even less likely that the countries which matter would do anything in response. Nor am I optimistic that we can sever the links connecting banking as a stodgy utility that provides essential services to the economy to banking as a casino offering opportunities for taking huge bets. Bankers have been given a licence to gamble with taxpayers' money. That is a wonderful business to be in. It is also one we seem unable to bring to heel. http://www.ft.com/cms/s/0/7cc47dfe-aa95-11dd-897c-000077b07658.html?nclick_check=1

But...

We are not just talking about "banks" since there are plenty non-bank organisations, states, individuals and corporations which can raise cash independently in order to pursue ("self-financed") risky investments. If it was just a matter of banks, the system would be much easier to control or bring to heel. Trichet now emphasizes it is "crucial that all parties, including public authorities, price-setters and social partners, fully live up to their responsibilities" to ensure price stability http://www.ecb.int/press/pressconf/2008/html/is081106.en.html

Economies functioned quite well for many years without a gigantic proliferation of risk-pricing aiming to make profit from redistributing the burden of risk, and there's no absolute reason why society could not approximate that situation again. For centuries, let us note, people took the same risks without those risks having any tradeable value of their own. It is absurd to me if people argue it's okay to smash the state and the infrastructure of Iraq, in order to rebuild the country from scratch, and then deny the possibility for prudent financial reform in societies enormously better resourced than that one.

Unfortunately the discussion of "risk" in modern economics has not yet advanced much beyond risk-pricing methodologies, i.e. beyond useful quantitative/technical insight into what particular risks are worth, given the state of the market, and their financial effects. But surely there is a crucial difference between insurance risk and entrepreneurial risk? I am quite happy with the idea that in any healthy society there will always be room for an entrepreneurial sector, appropriately rewarded for risk-taking, and for finance to support it. Point however is, we ought to be clear about what kind of entrepreneurship, and what kind of risk-taking we are really talking about. If the "risk-taking" consists just in inventing a profitable insurance system for capital, which fails because its uncontrolled practices lead to a disastrous over-extension of credit, and makes the lives of all more insecure as a result, that sort of risk-taking is surely not worth having?

It is ironic to argue that forecasters cannot "provide reliable warnings of looming crises". Of course they can, and they have - if you are prepared to study the record of prediction. The whole financial risk-taking business has indeed powerfully developed the human ability for foresight and forecasting, which is a positive gain - its successes have been due precisely to the ability to make lucid analyses of future developments. The problem is rather different: (1) such foreknowledge is itself worth a lot of money, and (2) competing interests often prevent it from being shared or becoming public knowledge, (3) even if we know something will happen it does not automatically mean we can do something about it. But surely it is possible to establish a non-partisan forecasting institution which employs the best scientific techniques available to make trustworthy forecasts benefiting everyone?

The theoretical argument against it is that such public forecasts would co-determine the outcomes you would get (and thus, that you can never remove "unintended consequences"); and that they cannot ultimately be divorced from a moral judgement about what is good for humanity - "there is a way of telling the truth". To a certain extent that line of thinking is correct, but if we drive the argument too far, then we really end up saying that all planning is impossible. But this is a mystification. Not only is planning possible and necessary; everybody does it all the time, and adjusts plans as circumstances change. Why should that adjustment necessarily have to be irrational, rather than informed by the best science? No corporation could exist without extensive planning, beyond the individual planner who necessarily plans his or her own activities.

If we downgrade the human capacity and potential for foresight, we are degrading one of our own best achievements, essential for mastering at least the basics of what happens to us, so that we can constructively orient our behaviour and learn from it. It just feeds into cultural pessimism about processes which are allegedly so complex that their effects cannot be understood.

According to NYT, it was just that the analysts got the numbers wrong http://www.nytimes.com/2008/11/05/business/05risk.html?em but the real problem was lending and borrowing for which participants themselves could not oversee the financial consequences, and an ideology which said that serious crises could not happen. That's not a problem of forecasting as such, but of social practices and ideological biases.
Jurriaan

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Received on Thu Nov 6 11:16:04 2008