Ten Years After Lehman: An Interest-Rate Perspective

by Edward Chancellor*

Back in November 2002, Ben Bernanke, then a governor of the Federal Reserve, attended Milton Friedman’s 90th birthday party. In his writings, the legendary monetarist had pinned the Great Depression on policy failures of the American central bank. Bernanke was a keen disciple and apologised to Friedman on behalf of his employer, vowing that the Fed wouldn’t make the same mistake again. Less than six years later, Bernanke found himself at the helm of the Fed on that fateful day, Sept. 15, 2008, when Lehman Brothers collapsed. Another Great Depression beckoned. But now the Fed chairman was ready to make good on his promise. Continue reading

Unintended Monetary Policy Effects – Tale II: ECB Crisis Policies

by Andreas Hoffmann and Nicolás Cachanosky

The Federal Reserve’s (Fed) and European Central Bank’s (ECB) policy responses to the recent financial disasters offer two tales of unintended consequences. Our previous post outlined undesired effects of the Fed’s policies. In this post, we suggest that the ECB’s stabilization policy did not only fail to achieve its goals. Monetary policy has also hampered the structural adjustment of the European economy and prolonged the crisis.

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Two Tales of Unintended Consequences of Monetary Policy – Tale 1

by Nicolás Cachanosky and Andreas Hoffmann

Even when a policy is successful in achieving its desired ends, we have to consider its unintended and unforeseen consequences, resulting from cumulative market adjustments to policy changes that make it hard to judge the overall outcome of a policy in our complex economy. The Federal Reserve and European Central Bank’s monetary policy responses to the 2008 financial crisis offer two tales of major unintended consequences. This post discusses unintended outcomes of the U.S. Federal Reserve’s crisis policies. In our next post, we address ECB policies.

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The Blanchard Danger

by Roger Koppl

Oliver Blanchard tells us “Where Danger Lurks”  in the macro-finance world.

The big theme is nonlinearity, which is a profoundly conservative move: DSGE modeling is just fine and we don’t need to rethink it at all. We just need to add in some nonlinearities. Blanchard does not tell how to calibrate a model with extreme sensitivity to initial conditions. But if the system is chaotic, it is also unpredictable, so how can you pretend to merely add nonlinearities to DSGE models?  It seems like a pretty direct contradiction to me. I mean, you can have the model in a trivial sense, of course. But calibration is an empty exercise that will not let you look around corners.

Blanchard’s second main message is alarming: We do need theoretical innovation, however, in measuring systemic risk. In the modern network literature on financial markets and cascades, one key point is risk externality. My portfolio choice makes your portfolio riskier. We need two things to fix this market failure. First, we need Pigou taxes, which cannot be calculated unless everyone tells the regulator his portfolio so that it can measure systemic risk and calculate a separate Pigou tax for each financial institution. Second, we need to reduce systemic risk. (“[S]teps must be taken to reduce risk and increase distance” from the “dark corners” of the macro-finance system.) In the network literature I suspect Blanchard is alluding to, this is to be done (at least in some of the articles) by having the regulator directly control the portfolios of financial institutions. (Names include: Acharya 2009; Beale et al. 2011; Caccioli et al. 2011; Gai, Haldane,and Kapadia 2011; Haldane and May 2011; and Yellen 2009, 2011)

I take a rather different view of both economic theory and the crisis in my recent IEA Hobart paper From Crisis to Confidence: Macroeconomics after the Crash.

Overall, Blanchard’s message is meant to be reassuring: We the smart macro-finance experts have now got the message on nonlinearities. So no further need to worry, we’ve got the situation in hand. To keep the system out of the “dark corners,” however, we will need more discretionary authority. You don’t mind trading off a bit of financial freedom for greater financial safety do you?

Capitalism Loses Against Chimera

by Chidem Kurdas

Gripes about capitalism go back 150 years and more. In the Communist Manifesto of 1848 Marx and Engels thundered that the specter of revolution haunted Europe, that the periodic reappearance of commercial crises “put on its trial, each time more threateningly, the existence of the entire bourgeois society.” They were not the first to assail the system and were followed by numerous others spanning the political spectrum.

Thus the Financial Times recently started a series on  “The Crisis of Capitalism.”  Europe suffers from a sovereign debt crisis due to over-spending by governments—why is that the crisis of capitalism? But one should not quibble. It is an old tradition. In the 1998 turmoil brought on by Russia’s default on its bonds and the failure of a large hedge fund, commentaries appeared bearing titles such as The Crisis in Global Capitalism, Global Capitalism RIP, Collapse of Capitalism, Who Lost Capitalism? and The Free Market’s Crisis of Faith.

I’ve taken those titles from a response by Michael Boskin, “Capitalism and its Discontents,” a classic that rings true 14 years later and merits re-reading.  Continue reading

Radical Ignorance in the Financial Crisis

by Sandy Ikeda

Jeffrey Friedman and Wladimir Kraus have a new book out, Engineering the Financial Crisis, (Univ. Penn Press) that grew out of research that first appeared in Critical Review back in 2009 on the “Causes of the Crisis.”  Friedman’s lead article in that issue did an excellent job of providing a detailed but readable description of the institutional setting of the crisis and an account of the complex events, domestic and international, that led to it.  I’ve only skimmed the book, but it appears offer a similar kind of useful description and analysis of these and many other events surrounding the crisis.

What distinguishes this book, and what may be of particular interest to readers of this blog, is it’s explicitly Austrian perspective on the role of ignorance, in the private but especially the public sector, as the analytical starting point of the crisis.

The meta-mistake that economists make in ignoring ignorance (or in reducing it to “rational” or deliberate ignorance or to “asymmetric information,” where one party does know the truth) is suggestive, we think, of the problems that modern democracy faces:  If economists are our most important advisers, but their worldviews have no place for genuine human error, we are in deep trouble (151).

A rationalist constructivist hubris led public authorities to create a “hybrid capitalism” that incited entrepreneurs to ever riskier investments, the consequences of which no one could foresee though they perhaps might have imagined.  The book’s title Engineering the Financial Crisis captures that idea well.

Bleeding the Economy

by Roger Koppl

At the Cobden Centre‘s website (and here), Steve Baker discusses recent Fed signals in the context of Big Players theory.  The more active the Fed (or other central bank), the greater the fraction of entrepreneurial attention devoted to Fed watching rather than productive activity.  As Baker says, “traders must pay attention to the Big Player and not the fundamentals.” Continue reading

What Kind of Doctor Is This?

by Gene Callahan

Let’s say you are suffering from a moderately severe cold; you’re operating at, say, 90% of your peak energy level, and so you go the doctor to see if he can help get you back to 100%. After examining you, the doctor says:

“The point of our therapy is to approach the current malady in the spirit that we’ll do whatever it takes to turn things around; if what has been done so far isn’t enough, do more and do something different, until health starts to flow and the patient starts to recover.”

Wouldn’t you be inclined to sprint out the door? Continue reading

“Causes of the Crisis Blog”

by Sandy Ikeda

Following up on its recent issue on the financial crisis, Critical Review has started a blog with contributors to that issue doing the posting.  So far they have “disputed the theory that bankers’ bonuses, irrational exuberance, or capitalism caused the crisis. And four posts have debated the role of economic theory in failing to understand the crisis.”

Contributors listed under the fold. Continue reading

Critical Review Explores The Causes Of The Financial Crisis

by Sandy Ikeda

The most recent issue of Critical Review on the Causes of the Financial Crisis includes contributions from John B. Taylor, Daron Acemoglu, Steven Gjerstad and Vernon L. Smith, Lawrence J. White, and Joseph E. Stiglitz to name just few.

I’ve not yet read the entire issue, but did have the opportunity to read an earlier draft of the introductory essay by CR’s editor, Jeff Friedman, entitled “A crisis of politics, not economics, complexity, ignorance, and policy failure.” While the title reveals where Friedman stands on the origins of the crisis, his emphasis on “ignorance” in particular reflects his appreciation of the role of what Kirzner has termed “sheer ignorance” in creating the unintended consequences that drive the dynamics of interventionism.  (He cites Hayek, Selgin, and myself, alas there is no reference to Kirzner.)  He points out the effect of policies not only on the existing structure of regulations, but also the impact on future, unknowable interventions

I also found that his article does an excellent job of clarifying a number of points for me, including the nature of tranches and CDOs, which to the uninitiated (like me) seem highly arcane, and shedding light on the subtle but crucial roles of the Basel I and II agreements in the crisis. It’s a very useful essay, telling what can be seen as an Austrian-based story of the financial crisis.

The Coming Slavery




It is said that when railways were first opened in Spain, peasants standing on the tracks were not [i]nfrequently run over; and that the blame fell on the engine-drivers for not stopping: rural experiences having yielded no conception of the momentum of a large mass moving at a high velocity.


The [above] incident is recalled to me on contemplating the ideas of the so-called “practical” politician, into whose mind there enters no thought of such a thing as political momentum, still less of a political momentum which, instead of diminishing or remaining constant, increases. The theory on which he daily proceeds is that the change caused by his measure will stop where he intends it to stop. He contemplates intently the things his act will achieve, but thinks little of the remoter issues of the movement his act sets up, and still less its collateral issues.


Herbert Spencer, “The Coming Slavery”




Quite a few years ago I gave a presidential address at a dinner meeting of the Society for the Development of Austrian Economics which was titled after Herbert Spencer’s 1884 article, “The Coming Slavery.” At that time I failed to understand the nature of an after-dinner talk and struck a too-somber tone for too long a time. Nevertheless, I have an enormous respect for Herbert Spencer and his analysis of the dynamics of government intervention in the economy and believe his observations are highly relevant to current events.


We are clearly on a slippery slope toward massive and ill-advised government interference in the market. Unlike many slippery slopes this one is not likely to take a long time. Continue reading