The Great Moderation

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Broken Markets: A User's Guide to the Post-Finance Economy by Kevin Mellyn

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The question is not so much why this all came tumbling down in 2008 as it is, “How did this house of cards stay up so long”? The short answer is cheap money over a long period of time. The Great Moderation The term Great Moderation was coined to describe the 25 years between 1983 and 2008 when inflation remained in check, the value of financial assets rose, and free market capitalism was in the ascendant position it had not occupied since the 1920s. Of course, unless you were sad to see the demise of Marxist-inspired state socialism, times were good with the exception of a few short recessions and a few special cases like Japan. It would be wrong, however, to attribute the Great Moderation to the inherent virtues of a financedriven global economy where the market rewarded good investments and punished bad ones. For example, the taming of inflation was an heroic one-off accomplishment of Paul Volcker at the Federal Reserve.

This allowed China, of course, to export more stuff and buy more bonds. Low and stable long-term interest rates allowed housing prices to rise and more people to afford houses. None of this was due to the genius of policymakers, though a reputed “maestro,” Alan Greenspan, occupied the chairmanship of the Board of Governors of the Federal Reserve System for 17 of the 25 years of the Great Moderation. Where the central bank and US Treasury policy was decisive during the Great Moderation was in protecting the financial economy from its own mistakes and excesses. On one level, this made sense, because the sheer scale of the financial economy relative to the real economy made the consequences of a market panic too scary to contemplate in terms of damage to real output and production. More controversially, the argument can be made that the financialization of wealth had created a new relationship between finance and government.

It is no surprise that using the resources of the US Treasury to pull Goldman Sachs’s fat out of fire seemed the simple pursuit of national interest. The markets and the largest investment-banking operations increasingly came to believe that the authorities would step in to prevent any reckoning for financial bets gone wrong. In this sense, the Great Moderation was at least as much a product of governments as it was of markets, something that pains the heart of free-market fundamentalists. The problem is that in a free market, everyone is free to fail. Indeed, something that Joseph Schumpeter called “creative destruction” is essential to economic progress.The Great Moderation was largely a one-way bet for market participants. Financial crises of one sort or another, which affected companies ranging from Japanese and Swedish banks to Long Term Capital, an American hedge fund, continued to occur. In fact, they became more frequent.


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Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

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The next two chapters will therefore look in detail at these less familiar transformations. The theme in the background of this discussion will be the way in which all the global megatrends reinforced one another, first in creating the period of remarkable economic stability that came to be known as the Great Moderation and then snapping back with a vengeance in the crisis of 2007-09. CHAPTER SIX The Great Moderation Practice moderation in all things, including moderation.1 —Gaius Petronius THE GREAT MODERATION was the title chosen by Ben Bernanke for a speech he delivered in February 2004. The speech was given to celebrate and explain the U.S. economy’s escape from what had been widely expected to be a serious and prolonged recession, following the boom and bust in technology shares. His speech began with this sentence: “One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility.”2 These words continued to ring true right up to the bankruptcy of Lehman on September 15, 2008.

The crucial point elided in Bernanke’s monetarist explanation of the Great Moderation—and in almost all official accounts of economic policy—was that central banks and governments quietly restored active demand management from the mid-1980s onward, carefully balancing the risks of high inflation and unemployment. Moreover, the central bankers had two great advantages compared to their Keynesian predecessors. They had learned from the bitter experience of the 1970s that greater weight must be attached than in the past to the risks of accelerating inflation, and they had more effective tools for macroeconomic management at their disposal, because of the unexpected triumph of pure fiat money after the breakdown of Bretton Woods. The result was the spectacular success of macroeconomic stabilization described as the Great Moderation—at least until the crisis of 2007.

But these days they must say that they are acting to prevent deflation, or even to increase inflation, instead of openly admitting that they are trying to reduce unemployment or support economic growth. Chapter 11 explains the economic ideology behind this strange rhetorical deformation. What matters in the present discussion is how the central bankers have actually behaved since the start of the Great Moderation. If we focus on actions, rather than rhetoric, it is clear that the Great Moderation began when policymakers, first in America and then in other countries, returned to the traditional Keynesian objectives of minimizing unemployment and stabilizing growth. In the United States, the return to demand management began as early as the summer of 1982, when a three-year recession and the bankruptcy of the Mexican government persuaded the Fed that its experiment with monetarism had gone too far.


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Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

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After the crisis hit, Taylor himself blamed it on the Fed deviating from his rule: Why did the Great Moderation end? In my view, the answer is simple. The Great Moderation ended because of a ‘Great Deviation,’ in which economic policy deviated from what was working well during the Great Moderation. Compared with the Great Moderation, policy became more interventionist, less rules-based, and less predictable. When policy deviated from what was working well, economic performance deteriorated. And lo and behold, we had the Great Recession. (Taylor 2007: 166) There is some merit in Taylor’s argument – certainly the low rates in that period encouraged the growth of Ponzi behavior in the finance sector. But his neoclassical analysis ignores the dynamics of private debt, which, as I show in Chapters 12 and 13, explain both the ‘Great Moderation’ and the ‘Great Recession.’

The link between the monetary and physical models is the creation of new money, which finances investment. The model generates as sudden a turnaround in output as any neoclassical model hit by ‘exogenous shocks,’ but unlike in those models there is continuity between the Great Moderation and the Great Recession. 14.14 Modeling the Great Moderation and the Great Recession – inflation, unemployment and debt 14.15 The Great Moderation and the Great Recession – actual inflation, unemployment and debt 14.16 Modeling the Great Moderation and the Great Recession – output The model’s numbers and the magnitude of its crash are hypothetical,16 and the main question is whether its qualitative behavior matches that of the US economy – which it clearly does. A period of extreme cycles in unemployment and inflation is followed by diminishing cycles which, if they were the only economic indicators one focused upon, would imply that a ‘Great Moderation’ was occurring.

A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data available eISBN 9781780322209 CONTENTS Tables, figures and boxes Preface to the second edition Preface to the first edition 1 Predicting the ‘unpredictable’ 2 No more Mr Nice Guy Part 1 Foundations: the logical flaws in the key concepts of conventional economics 3 The calculus of hedonism 4 Size does matter 5 The price of everything and the value of nothing 6 To each according to his contribution Part 2 Complexities: issues omitted from standard courses that should be part of an education in economics 7 The holy war over capital 8 There is madness in their method 9 Let’s do the Time Warp again 10 Why they didn’t see it coming 11 The price is not right 12 Misunderstanding the Great Depression and the Great Recession Part 3 Alternatives: different ways to think about economics 13 Why I did see ‘It’ coming 14 A monetary model of capitalism 15 Why stock markets crash 16 Don’t shoot me, I’m only the piano 17 Nothing to lose but their minds 18 There are alternatives Bibliography Index TABLES, FIGURES AND BOXES Tables 2.1 Anticipations of the housing crisis and recession 3.1 ‘Utils’ and change in utils from consuming bananas 3.2 Utils arising from the consumption of two commodities 3.3 The commodities in Sippel’s ‘Revealed Preference’ experiment 4.1 Demand schedule for a hypothetical monopoly 4.2 Costs for a hypothetical monopoly 4.3 Sales and costs determine the level of output that maximizes profit 4.4 Cost and revenue for a ‘perfectly competitive’ industry identical in scale to hypothetical monopoly 5.1 Input and output data for a hypothetical firm 5.2 Cost drawings for the survey by Eiteman and Guthrie 5.3 Empirical research on the nature of cost curves 7.1 Sraffa’s hypothetical subsistence economy 7.2 Production with a surplus 7.3 Relationship between maximum and actual rate of profit and the wage share of surplus 7.4 The impact of the rate of profit on the measurement of capital 10.1 Anderson’s ranking of sciences 12.1 The alleged Money Multiplier process 13.1 A hypothetical example of the impact of decelerating debt on aggregate demand 13.2 The actual impact of decelerating debt on aggregate demand 14.1 A pure credit economy with paper money 14.2 The dynamics of a pure credit economy with no growth 14.3 Net incomes 14.4 A growing pure credit economy with electronic money 15.1 Von Neumann’s procedure for working out a numerical value for utility 15.2 The Allais ‘Paradox’ 15.3 The Allais ‘Paradox’ Part 2 16.1 The solvability of mathematical models 17.1 Marx’s unadjusted value creation table, with the rate of profit dependent upon the variable-to-constant ratio in each sector 17.2 Marx’s profit distribution table, with the rate of profit now uniform across sectors 17.3 Steedman’s hypothetical economy 17.4 Steedman’s physical table in Marx’s value terms 17.5 Steedman’s prices table in Marx’s terms 17.6 Profit rate and prices calculated directly from output/wage data 17.7 Marx’s example where the use-value of machinery exceeds its depreciation Figures 2.1 US inflation and unemployment from 1955 2.2 Bernanke doubles base money in five months 2.3 Private debt peaked at 1.7 times the 1930 level in 2009 3.1 Rising total utils and falling marginal utils from consuming one commodity 3.2 Total utils from the consumption of two commodities; 3.3 Total ‘utils’ represented as a ‘utility hill’ 3.4 The contours of the ‘utility hill’ 3.5 Indifference curves: the contours of the ‘utility hill’ shown in two dimensions 3.6 A rational consumer’s indifference map 3.7 Indifference curves, the budget constraint, and consumption 3.8 Deriving the demand curve 3.9 Upward-sloping demand curve 3.10 Separating out the substitution effect from the income effect 3.11 Engel curves show how spending patterns change with increases in income 3.12 A valid market demand curve 3.13 Straight-line Engel ‘curves’ 3.14 Economic theory cannot rule out the possibility that a market demand curve may have a shape like this, rather than a smooth, downward-sloping curve 4.1 Leijonhufvud’s ‘Totems’ of the Econ tribe 4.2 Stigler’s proof that the horizontal firm demand curve is a fallacy 4.3 Profit maximization for a monopolist: marginal cost equals marginal revenue, while price exceeds marginal cost 4.4 Profit maximization for a perfectly competitive firm: marginal cost equals marginal revenue, which also equals price 4.5 A supply curve can be derived for a competitive firm, but not for a monopoly 4.6 A competitive industry produces a higher output at a lower cost than a monopoly 4.7 The standard ‘supply and demand’ explanation for price determination is valid only in perfect competition 4.8 Double the size, double the costs, but four times the output 4.9 Predictions of the models and results at the market level 4.10 Output behavior of three randomly selected firms 4.11 Profit outcomes for three randomly selected firms 4.12 Output levels for between 1- and 100-firm industries 5.1 Product per additional worker falls as the number of workers hired rises 5.2 Swap the axes to graph labor input against quantity 5.3 Multiply labor input by the wage to convert Y-axis into monetary terms, and add the sales revenue 5.4 Maximum profit occurs where the gap between total cost and total revenue is at a maximum 5.5 Deriving marginal cost from total cost 5.6 The whole caboodle: average and marginal costs, and marginal revenue 5.7 The upward-sloping supply curve is derived by aggregating the marginal cost curves of numerous competitive firms 5.8 Economic theory doesn’t work if Sraffa is right 5.9 Multiple demand curves with a broad definition of an industry 5.10 A farmer who behaved as economists advise would forgo the output shown in the gap between the two curves 5.11 Capacity utilization over time in the USA 5.12 Capacity utilization and employment move together 5.13 Costs determine price and demand determines quantity 5.14 A graphical representation of Sraffa’s (1926) preferred model of the normal firm 5.15 The economic theory of income distribution argues that the wage equals the marginal product of labor 5.16 Economics has no explanation of wage determination or anything else with constant returns 5.17 Varian’s drawing of cost curves in his ‘advanced’ microeconomics textbook 6.1 The demand for labor curve is the marginal revenue product of labor 6.2 The individual’s income–leisure trade-off determines how many hours of labor he supplies 6.3 An upward-sloping individual labor supply curve 6.4 Supply and demand determine the equilibrium wage in the labor market 6.5 Minimum wage laws cause unemployment 6.6 Demand management policies can’t shift the supply of or demand for labor 6.7 Indifference curves that result in less work as the wage rises 6.8 Labor supply falls as the wage rises 6.9 An individual labor supply curve derived from extreme and midrange wage levels 6.10 An unstable labor market stabilized by minimum wage legislation 6.11 Interdependence of labor supply and demand via the income distributional effects of wage changes 7.1 The standard economic ‘circular flow’ diagram 7.2 The rate of profit equals the marginal product of capital 7.3 Supply and demand determine the rate of profit 7.4 The wage/profit frontier measured using the standard commodity 9.1 Standard neoclassical comparative statics 9.2 The time path of one variable in the Lorenz model 9.3 Structure behind the chaos 9.4 Sensitive dependence on initial conditions 9.5 Unstable equilibria 9.6 Cycles in employment and income shares 9.7 A closed loop in employment and wages share of output 9.8 Phillips’s functional flow block diagram model of the economy 9.9 The component of Phillips’s Figure 12 including the role of expectations in price setting 9.10 Phillips’s hand drawing of the output–price-change relationship 9.11 A modern flow-chart simulation program generating cycles, not equilibrium 9.12 Phillips’s empirically derived unemployment–money-wage-change relation 10.1 Hicks’s model of Keynes 10.2 Derivation of the downward-sloping IS curve 10.3 Derivation of the upward-sloping LM curve 10.4 ‘Reconciling’ Keynes with ‘the Classics’ 10.5 Unemployment–inflation data in the USA, 1960–70 10.6 Unemployment–inflation data in the USA, 1950–72 10.7 Unemployment–inflation data in the USA, 1960–80 10.8 The hog cycle 11.1 Supply and demand in the market for money 11.2 The capital market line 11.3 Investor preferences and the investment opportunity cloud 11.4 Multiple investors (with identical expectations) 11.5 Flattening the IOC 11.6 How the EMH imagines that investors behave 11.7 How speculators actually behave 12.1 Inflation and base money in the 1920s 12.2 Inflation and base money in the post-war period 12.3 Bernanke’s massive injection of base money in QE1 12.4 Change in M0 and unemployment, 1920–40 12.5 Change in M1 and unemployment, 1920–40 12.6 Change in M0 and M1, 1920–40 12.7 M0–M1 correlation during the Roaring Twenties 12.8 M0–M1 correlation during the Great Depression 12.9 Bernanke’s ‘quantitative easing’ in historical perspective 12.10 The volume of base money in Bernanke’s ‘quantitative easing’ in historical perspective 12.11 Change in M1 and inflation before and during the Great Recession 12.12 The money supply goes haywire 12.13 Lindsey, Orphanides, Rasche 2005, p. 213 12.14 The empirical ‘Money Multiplier’, 1920–40 12.15 The empirical ‘Money Multiplier’, 1960–2012 12.16 The disconnect between private and fiat money during the Great Recession 13.1 Goodwin’s growth cycle model 13.2 My 1995 Minsky model 13.3 The vortex of debt in my 1995 Minsky model 13.4 Cyclical stability with a counter-cyclical government sector 13.5 Australia’s private debt-to-GDP ratio, 1975–2005 13.6 US private debt to GDP, 1955–2005 13.7 Aggregate demand in the USA, 1965–2015 13.8 US private debt 13.9 The change in debt collapses as the Great Recession begins 13.10 The Dow Jones nosedives 13.11 The correlation of debt-financed demand and unemployment 13.12 The housing bubble bursts 13.13 The Credit Impulse and change in employment 13.14 Correlation of Credit Impulse and change in employment and GDP 13.15 Relatively constant growth in debt 13.16 The biggest collapse in the Credit Impulse ever recorded 13.17 Growing level of debt-financed demand as debt grew faster than GDP 13.18 The two great debt bubbles 13.19 Change in nominal GDP growth then and now 13.20 Real GDP growth then and now 13.21 Inflation then and now 13.22 Unemployment then and now 13.23 Nominal private debt then and now 13.24 Real debt then and now 13.25 Debt to GDP then and now 13.26 Real debt growth then and now 13.27 The collapse of debt-financed demand then and now 13.28 Debt by sector – business debt then, household debt now 13.29 The Credit Impulse then and now 13.30 Debt-financed demand and unemployment, 1920–40 13.31 Debt-financed demand and unemployment, 1990–2011 13.32 Credit Impulse and change in unemployment, 1920–40 13.33 Credit Impulse and change in unemployment, 1990–2010 13.34 The Credit Impulse leads change in unemployment 14.1 The neoclassical model of exchange as barter 14.2 The nature of exchange in the real world 14.3 A nineteenth-century private banknote 14.4 Bank accounts 14.5 A credit crunch causes a fall in deposits and a rise in reserves in the bank’s vault 14.6 A bank bailout’s impact on loans 14.7 A bank bailout’s impact on incomes 14.8 A bank bailout’s impact on bank income 14.9 Bank income grows if debt grows more rapidly 14.10 Unemployment is better with a debtor bailout 14.11 Loans grow more with a debtor bailout 14.12 Profits do better with a debtor bailout 14.13 Bank income does better with a bank bailout 14.14 Modeling the Great Moderation and the Great Recession – inflation, unemployment and debt 14.15 The Great Moderation and the Great Recession – actual inflation, unemployment and debt 14.16 Modeling the Great Moderation and the Great Recession – output 14.17 Income distribution – workers pay for the debt 14.18 Actual income distribution matches the model 14.19 Debt and GDP in the model 14.20 Debt and GDP during the Great Depression 15.1 Lemming population as a constant subject to exogenous shocks 15.2 Lemming population as a variable with unstable dynamics 17.1 A graphical representation of Marx’s dialectics Boxes 10.1 The Taylor Rule 13.1 Definitions of unemployment PREFACE TO THE SECOND EDITION Debunking Economics was far from the first book to argue that neoclassical economics was fundamentally unsound.


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The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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Taylor, eds, Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century (Chicago: University of Chicago Press, 2013). 2. Gordon Brown, ‘Speech to the Labour Party Conference in Brighton’, 27 September 2004, http://news.bbc.co.uk/1/hi/uk_politics/3694046.stm. 3. Ben Bernanke, ‘The Great Moderation’, 20 February 2004, http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm. 4. James H. Stock and Mark W. Watson coined the term ‘great moderation’ in ‘Has the Business Cycle Changed and Why?’, in Mark Gertler and Kenneth Rogoff, eds, NBER Macroeconomic Annual 2012, vol. 17 (Cambridge, MA: MIT Press, 2003), http://www.nber.org/chapters/c11075.pdf. 5. Bernanke, ‘The Great Moderation’. 6. Foremost among the economists whose views were widely ignored were the late Hyman Minsky and Charles Kindleberger. See, for example, Hyman P. Minsky, Stabilizing an Unstable Economy (New Haven: Yale University Press, 1986), and Charles P.

It focused particularly on the implications of the linked phenomena of the yawning US current-account deficits, the accumulations of foreign-currency reserves by emerging economies, and the imbalances within the Eurozone.2 That discussion arose naturally from the consideration of finance in my earlier book, Why Globalization Works, published in 2004.3 That book, while arguing strongly in favour of globalization, stressed the heavy costs of financial crises. Nevertheless, I did not expect these trends to end in so enormous a financial crisis, so comprehensive a rescue, or so huge a turmoil within the Eurozone. My failure was not because I was unaware that what economists called the ‘great moderation’ – a period of lower volatility of output in the US, in particular, between the late 1980s and 2007 – had coincided with large and potentially destabilizing rises in asset prices and debt.4 It was rather because I lacked the imagination to anticipate a meltdown of the Western financial system. I was guilty of working with a mental model of the economy that did not allow for the possibility of another Great Depression or even a ‘Great Recession’ in the world’s most advanced economies.

Introduction: ‘We’re not in Kansas any more’1 No longer the boom-bust economy, Britain has had the lowest interest rates for forty years. And no longer the stop-go economy, Britain is now enjoying the longest period of sustained economic growth for 200 years. Gordon Brown, 2004 2 My view is that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation. In particular, I am not convinced that the decline in macroeconomic volatility of the past two decades was primarily the result of good luck, as some have argued, though I am sure good luck had its part to play as well. Ben Bernanke, Governor of the Federal Reserve Board, 20043 The past is a foreign country. Even the quite recent past is a foreign country. That is certainly true of the views of leading policymakers.


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Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

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Affordable Care Act / Obamacare, Air France Flight 447, air freight, airport security, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, capital controls, central bank independence, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, Daniel Kahneman / Amos Tversky, diversified portfolio, double helix, endowment effect, Exxon Valdez, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, global supply chain, hindsight bias, Hyman Minsky, Joseph Schumpeter, Kenneth Rogoff, London Whale, Long Term Capital Management, market bubble, moral hazard, Network effects, new economy, offshore financial centre, paradox of thrift, pets.com, Ponzi scheme, quantitative easing, Ralph Nader, Richard Thaler, risk tolerance, Ronald Reagan, savings glut, technology bubble, The Great Moderation, too big to fail, transaction costs, union organizing, Unsafe at Any Speed, value at risk

The successful containment of both inflation and banking instability was not enough to bring on a crisis; attitudes about risk had to change. And that they did. By making the economy seem safer, the Great Moderation also changed attitudes about debt. The Great Depression had left a lasting wariness of debt. When, in the postwar period, the newly prosperous middle class bought homes, cars, and appliances and rediscovered installment credit, the rapid growth in consumer debt brought no end of angst. “The bald, unadorned figures of consumer-credit expansion smell of a credit binge,” Fortune magazine warned in 1956, in an article for which Alan Greenspan, then a young consultant, provided the data. “The turn in consumer credit would powerfully accelerate a general recession.” By the time of the Great Moderation, however, views had begun to shift. Debt was, after all, only one side of the balance sheet—the liability side.

The twenty-five years before the global financial crisis were unusually peaceful for the economy; recessions were rare and mild, inflation was low and stable, and periodic financial crises, whether the stock market crash of 1987 or the Asian financial crisis of 1997, were contained by the global fire brigades—the Fed, the Treasury, and the International Monetary Fund. Economists called this era the “Great Moderation,” and credited it to changes in how businesses operated—using fewer inventories, for example—and a more disciplined, more nimble Federal Reserve, able to snuff out both inflation and recession. The global economy in 2008 was like a forest that hadn’t burned in decades; it was choking with the fuel of leverage, risk, and complacency. Making everyday life safer and more secure is one of the purposes of government, and for the past century it’s been quite successful: our roads and our skies have gotten steadily safer, death rates from infectious disease have plummeted, absolute poverty has shrunk, and, at least until 2008, savage recessions had become a thing of the past.

The 2001 recession was the mildest since the Second World War. With steady growth and stable inflation, the 1990s became known as the “Goldilocks” economy: not too hot, not too cold. In 2002 economists Mark Watson and James Stock came up with a grander label. They fed a wealth of data into their computer models and identified a remarkable decline in the volatility of growth, inflation, and interest rates since 1984, dubbing this period “the Great Moderation.” Theories abounded as to why the business cycle had been tamed: some said it was good luck, including fewer oil price shocks. Some credited better business practice, including tighter control of inventories. Ben Bernanke, an economist steeped in the theory and history of monetary policy who joined the Fed in 2002, credited one factor above all: the Fed had become far more adept at nipping inflation in the bud.


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Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

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Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, Bretton Woods, Brownian motion, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, full employment, George Akerlof, Goldman Sachs: Vampire Squid, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, invisible hand, Jean Tirole, joint-stock company, Kenneth Rogoff, knowledge economy, l'esprit de l'escalier, labor-force participation, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, payday loans, Ponzi scheme, precariat, prediction markets, price mechanism, profit motive, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, school choice, sealed-bid auction, Silicon Valley, South Sea Bubble, Steven Levy, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, War on Poverty, Washington Consensus, We are the 99%, working poor

With the shallow hindsight of seven years, these assertions still hold the power to cause the toughest orthodox neoclassicist to cringe with embarrassment: One of the most striking features of the economic landscape over the last twenty years or so has been a substantial decline in macroeconomic volatility . . . Three types of explanations have been suggested . . . structural change, macroeconomic policies, and good luck . . . My view is that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation . . . the policy explanation for the Great Moderation deserves more credit than it has received in the literature.48 His repeated assertion of this thesis in the intervening years went some distance in explaining why Bernanke’s Fed did essentially nothing to curb the worst financial abuses that led up to the crisis of 2007–8; Bernanke had been insisting throughout that the mortgage market was sound, hedge funds were “disciplined,” and the banks solid right up to the onset of the failure of Lehman Brothers.

This self-congratulation persisted even though a few inside figures such as the Fed governor Ned Gramlich (who was forced to resign in 2005) and the Atlanta Fed president, Jack Guynn, had been sounding the alarm since 2005. It is difficult to convey in any short space just how much the orthodox economics profession loved this trope of the Great Moderation and its ballyhooed prophet; so much so that it spawned a huge academic literature in its own right. Not only did highly ranked economics journals continue to publish articles discussing the Great Moderation long after the crash rendered the very idea ludicrous, but (having no shame) some tone-deaf economists even argued that the crisis had in no way impugned the existence of a Great Moderation. And neoclassical economists wonder why outsiders tend to snicker at them behind their backs.49 But to return to the Fed: because Bernanke had previously been a Princeton professor, and had been reappointed by Barack Obama, the media and the public seemed to conceive of the curious notion that Bernanke must be some sort of “centrist” or Roosevelt technocrat, and no shill for neoliberal capitulation to the financial sector.

MacKenzie, An Engine, Not a Camera and “The Credit Crisis as a Problem in the Sociology of Knowledge”; Mehrling, Fischer Black and the Revolutionary Idea of Finance. 45 MacKenzie, An Engine; O’Neill, “Black Scholes and the Normal Distribution”; Sherman, “Revolver.” 46 Bullock, “Friedman Economics”; Khademian, “The Pracademic and the Fed,” p. 142; Bernanke, congressional testimony, 2006. 47 The phrase was actually first coined by the Harvard economists James Stock and Mark Watson in 2002. 48 Bernanke, “The Great Moderation.” 49 Bernanke, congressional testimony, 2007; Leonard, “Alan Greenspan’s Housing Bubble Coffee Break”; Olivier Coibion and Yuri Gorodnichenko, “Did the Great Recession Mean the End of the Great Moderation?” at www.voxeu.org/index.php?q=node/4496. 50 Khademian, “The Pracademic and the Fed”; Lowenstein, “The Villain.” 51 Although one might want to insist upon the doctrinal differences between Randian libertarians and the Chicago School for some conceptual purposes, it is noteworthy that Milton Friedman was a vocal supporter of the Greenspan record in the press (Auerbach, Deception and Abuse at the Fed, p. 246n54). 52 Khademian, “The Pracademic and the Fed,” p. 146. 53 Bullock, “Friedman Economics.” 54 Partnoy, “Sunlight Shows Cracks in Crisis Rescue Story”; Chan and Protess, “Cross Section of Rich Invested with Fed”; Ivry, Keoun, and Kuntz, “Secret Fed Loans Helped Banks Net $13 Billion.” 55 Bernanke has changed his tune a few times over just why the Fed had to let Lehman fail.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, joint-stock company, Kenneth Rogoff, labour market flexibility, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce

In the US consumer prices rose more than fivefold between 1971 and 2010; in Britain, the increase was tenfold. The effect was fastest in the 1970s, when US prices more than doubled and in Britain they increased more than threefold. After that, central banks managed to get a handle on inflation. The period after 1982 has been described by economists as the ‘great moderation’ because economic growth was steady and recessions rare while inflation was generally low, except for a brief period at the end of the 1980s. The great moderation was accompanied by an extraordinary boom in asset markets. Share prices had really suffered in the 1970s, under pressure from double digit inflation and falling output; the real value of US share prices fell by 42 per cent between 1972 and 1982, according to Barclays Capital. In Britain, share prices fell by 31 per cent in real terms in 1973 and by a further 55 per cent in 1974.

So the commercial banks moved into the business of trading and market-making, either taking over existing investment banks or creating their own subsidiaries. The remaining investment banks raised capital by floating on the stock market. Even Goldman Sachs abandoned its cherished partnership structure in 1999. The banks could not have done this if the economy had not prospered. In a sense, the ‘great moderation’ of the 1980s and the boom in the financial sector were locked together. Banks make their money in three broad ways: from lending money at a higher rate than they borrow it; by owning assets that rise in price; and through earning fees for giving advice. The great moderation was thus ideal for their purposes. The infrequency of recessions meant that borrowers were both willing to take out more loans and more able to repay their debts. Buoyant economic conditions led to rising equity and property prices. They also encouraged companies to float on the stock market and to make acquisitions – activities that are lucrative fee-earners for the sector.

After all, most of their big bets will have come off in the past. Similarly, each banker sees himself in competition with rivals at other firms. The money is just a way of keeping score; they will always want more than the next guy. That means taking more risks. Their long-term prosperity is assured because they have already cashed in vast numbers of shares in previous years. From time to time during the ‘great moderation’, the risks involved in banking were revealed as banks went bust. The collapses of Johnson Matthey in 1984 and BCCI in 1991 showed that banks could go bust the old-fashioned way: by lending money to people who could not pay it back. The failure of Barings in 1995 was a more modern story, linked to the derivatives market. It revealed an astonishing naivety and lack of controls on the part of the Barings management.


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What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

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affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, invisible hand, Just-in-time delivery, Kenneth Rogoff, labour market flexibility, labour mobility, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, women in the workforce, yield curve

First, banking authorities agreed to the first set of international capital regulations (Basle I) in the late 1980s, and these regulations took effect before the end of 1992. While the post-2007 crisis has been of appalling severity, banks were subject to more or less the same capital regime in the fifteen years from 1992 to 2007, a period celebrated as the “Great Moderation” because of its benign macro outcomes. (In qualification, a somewhat different set of rules—Basle II—was adopted in 2004, although these rules were not fully and universally implemented before the onset of the crisis in mid-2007.) If the Basle capital regime was to blame for the crisis, why was it not also responsible for the Great Moderation? As macro outcomes were so good for so long, is it really beyond dispute that the capital rules were too lax and needed to be tightened up? Second, although thousands of banks have been affected by the crisis to some extent, numerous institutions are now emerging—usually after a round of capital raising—with relatively little damage.

Louis-Vincent Gave notes that Asian stock markets are now discounting high growth expectations, and thus are trading at premiums to traditional OECD markets. Gave reviews the four key factors that have driven economic performance in the West over the past decade, and suggests that some of the factors are still driving Asian growth. These factors are the emergence of three billion new producers, creation of a global economy, and the great moderation of steady low-inflation economic growth, and financial innovation. The financial revolution that drove markets in New York and London is still evolving in East Asia. East Asia is also free of two problems that now loom over the old industrial countries—a legacy of private debt that financed asset inflation and large fiscal deficits. Gave’s new concern is that China could soon confront labor shortages.

The result was an upsurge of productivity growth and wealth creation, especially in China and other previously backward Asian countries. The process of globalization transferred many manufacturing industries from the advanced economies to the developing world, vastly increasing the world’s productive capacity. The transfer of industrial activity made the world economy more prosperous and more stable, which brings us to the third megatrend. • The Great Moderation: A period of unprecedented stability in inflation, unemployment, and economic cycles that created twenty years of almost continuous growth throughout the world economy that lasted right up to the recession of 2008–2009. As the world began to recover from the recurrent crises of the 1970s and learned to live with pure fiat money, governments and central banks gained previously unimagined freedom to manage their economies and stabilize both inflation and unemployment.


pages: 258 words: 63,367

Making the Future: The Unipolar Imperial Moment by Noam Chomsky

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Albert Einstein, Berlin Wall, Bretton Woods, British Empire, capital controls, collective bargaining, corporate governance, corporate personhood, deindustrialization, energy security, failed state, Fall of the Berlin Wall, financial deregulation, Frank Gehry, full employment, Howard Zinn, Joseph Schumpeter, kremlinology, Long Term Capital Management, market fundamentalism, Mikhail Gorbachev, Occupy movement, oil shale / tar sands, precariat, RAND corporation, Ronald Reagan, structural adjustment programs, The Great Moderation, too big to fail, uranium enrichment, Washington Consensus, WikiLeaks, working poor

During the Great Moderation, American workers had become accustomed to a precarious existence. The rise of an American precariat was proudly hailed as a primary factor in the Great Moderation that brought slower economic growth, virtual stagnation of real income for the majority of the population, and wealth beyond the dreams of avarice for a tiny sector, mostly the agents of this historical transformation. The high priest of this magnificent economy was Alan Greenspan, described by the business press as “saintly” for his brilliant stewardship. Glorying in his achievements, he testified before Congress that they relied in part on “atypical restraint on compensation increases [which] appears to be mainly the consequence of greater worker insecurity.” The disaster of the Great Moderation was salvaged by heroic government efforts to reward the perpetrators.

Washington’s dismissal of some conventions supported by the International Labor Organization contrasts sharply with its dedication to enforcement of monopoly-pricing rights for corporations, disguised under the mantle of “free trade” in one of the contemporary Orwellisms. In 2004, the ILO reported that “economic and social insecurities were multiplying with globalization and the policies associated with it, as the global economic system has become more volatile and workers were increasingly shouldering the burden of risk, for instance, though pension and health care reforms.” This was what economists call the period of the Great Moderation, hailed as “one of the great transformations of modern history,” led by the United States and based on “liberation of markets,” particularly “deregulation of financial markets.” This paean to the American way of free markets was delivered by Wall Street Journal editor Gerard Baker in January 2007, just months before the system crashed—and with it the entire edifice of the economic theology on which it was based—bringing the world economy to near disaster.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

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Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business process, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, The Great Moderation, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve

In actuality, the market environment throughout the 1980s and 1990s rendered these decisions inconsequential as both stocks and bonds benefited greatly from falling inflation and declining interest rates. The environment later became known as the Great Moderation, and was summed up well in a 2004 speech by then-Federal Reserve Governor Ben Bernanke (see box). Bernanke on the Great Moderation The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development. Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed. I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well.

The largest U.S. pension fund, the California Public Employees’ Retirement System (CalPERS), for example, had a maximum allocation to equities of 25 percent, which was eventually lifted in 1984. Figure 1.3 U.S. Stocks and Bonds, 1970s SOURCE: Bloomberg; U.S. Bureau of Labor Statistics, http://www.bls.gov/CPI/; and Damodaran Online, http://pages.stern.nyu.edu/~adamodar/. The 60-40 Model and the Great Moderation Through the 1980s and 1990s, pensions continued to shift their assets out of bonds and into stocks, ultimately moving toward the now ubiquitous 60-40 policy portfolio (60 percent in stocks and 40 percent in bonds, often domestic only). The 60-40 model which became the standard benchmark by which to judge portfolio performance. The shift into stocks, and corresponding increase in risk, occurred in lock step with Federal Reserve Chairman Paul Volcker’s famous battle with inflation, which saw the fed funds rate peak at 20 percent in 1981.

Consequently, we do not expect that the same forecasting model will continue to dominate in different historical or future periods, and we try to use the appropriate model for a given paradigm; (2) The choice of sample period used to estimate the forecasting model parameters is important given model instability due to institutional shifts, changes in government policy, large technology or supply shocks, and other factors (i.e., the Great Moderation that began in the mid-1980s and ended recently); and (3) Forecast combinations can sometimes be better than trying to select one “best” model. The point is that we always have an economic prior, even before data enters the equation. As such, using guidance from economic theory for quantitative and qualitative searches, we identify possible trade opportunities that can be researched further.


pages: 561 words: 87,892

Losing Control: The Emerging Threats to Western Prosperity by Stephen D. King

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Admiral Zheng, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, BRICs, British Empire, capital controls, Celtic Tiger, central bank independence, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, demographic dividend, demographic transition, Deng Xiaoping, Diane Coyle, Fall of the Berlin Wall, financial deregulation, financial innovation, Francis Fukuyama: the end of history, full employment, George Akerlof, German hyperinflation, Gini coefficient, hiring and firing, income inequality, income per capita, inflation targeting, invisible hand, Isaac Newton, knowledge economy, labour market flexibility, labour mobility, low skilled workers, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, Naomi Klein, new economy, Ponzi scheme, price mechanism, price stability, purchasing power parity, rent-seeking, reserve currency, rising living standards, Ronald Reagan, savings glut, Silicon Valley, Simon Kuznets, sovereign wealth fund, spice trade, statistical model, technology bubble, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas Malthus, trade route, transaction costs, Washington Consensus, women in the workforce, working-age population, Y2K, Yom Kippur War

Yet exchange rates, interest rates, commodity prices, manufactured-goods prices and all sorts of other prices are now increasingly under the emerging economies’ spell. For a while, it was possible for central banks to kid themselves that their sovereignty was still intact. From the late 1980s through to the early years of the new millennium, the developed world supposedly benefited from the ‘Great Moderation’, a process whereby inflation and interest rates gradually fell, where business cycles became less volatile and where global economic growth strengthened in relation to the 1970s and early 1980s.9 Yet this moderation was followed by possibly the worst, and certainly the most synchronized, global economic downswing since the 1930s. If inflation was so low, why did things go so badly wrong?

FROM STABILITY TO INSTABILITY: WHY PRICE STABILITY DOESN’T ALWAYS LIVE UP TO ITS PROMISE Part of the explanation relates to an increased globalization of the inflation process. For central banks, charged with the need to deliver price stability at the national or continental level, this change has created three significant challenges. First, inflationary surprises in either direction may have nothing to do with the amount of money swirling around an economy, or the prevailing interest rate. The Great Moderation, for example, may have been more a result of good luck rather than inspired monetary judgement, reflecting the impact of outsourcing and off-shoring on the prices of manufactured goods. Responding through monetary policy to these kinds of inflationary surprises may, thus, add to economic and financial instability. If prices fall in relation to wages, as happened during the Moderation, why encourage even more spending by keeping interest rates low as well?

Whether through currency pegs, carry trades, unexpected price shocks or any one of a number of other examples, central banks are, individually, not as powerful as they’d like to believe. The gravitational pull being exercised by the emerging markets should change for ever the cosy Western attitudes towards monetary policy. No longer are developed-world central banks in control. The key question for policymakers to ask is this: if price stability is all it’s believed to be, why was its achievement during the Great Moderation followed by one of the biggest economic crises of the past hundred years? The standard response is to argue that price stability is a necessary but not sufficient guarantee of lasting economic success. Pursued too blindly, however, it seems to me that the achievement of price stability has, in fact, become a potential source of economic failure. Central bankers do not take seriously enough the distortions to prices and wages stemming from the emerging world.


pages: 361 words: 97,787

The Curse of Cash by Kenneth S Rogoff

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Andrei Shleifer, Asian financial crisis, bank run, Ben Bernanke: helicopter money, Berlin Wall, bitcoin, blockchain, Bretton Woods, capital controls, Carmen Reinhart, cashless society, central bank independence, cryptocurrency, debt deflation, distributed ledger, Edward Snowden, ethereum blockchain, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial intermediation, financial repression, forward guidance, frictionless, full employment, George Akerlof, German hyperinflation, illegal immigration, inflation targeting, informal economy, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, money: store of value / unit of account / medium of exchange, moral hazard, moveable type in China, New Economic Geography, offshore financial centre, oil shock, open economy, payday loans, price stability, purchasing power parity, quantitative easing, RAND corporation, RFID, savings glut, secular stagnation, seigniorage, The Great Moderation, the payments system, transaction costs, unbanked and underbanked, unconventional monetary instruments, underbanked, unorthodox policies, Y2K, yield curve

Obviously, with the experience of the financial crisis of 2008 behind us, and most major central banks stuck for years at the moral equivalent of the zero bound, these early sanguine estimates have to be reevaluated. The results of early Fed research on the likelihood and severity of zero bound episodes have had to be revised for basically five reasons. First, many of the early models were estimated over the Great Moderation period (from the mid-1980s until the financial crisis started unfolding in 2007), when macroeconomic volatility was very low.18 Second, the equilibrium global short-term real interest rate has dropped dramatically from the 2.0% enshrined in early versions of John Taylor’s famous monetary policy rule to anywhere from –1.0% to +1.0% today. A lower real interest rate gives less of a cushion before nominal policy interest rates hit zero; a section in the appendix illustrates the Taylor rule and how the presumed equilibrium real interest rate is an important consideration in determining whether central banks might want to set policy rates at negative levels.19 A third reason is that the models used in simulating the effects of the zero bound generally do a poor job of capturing the sluggishness that characterizes post–financial crisis growth, typically predicting a much faster snap back.

It is helpful to begin with policy prescriptions that are based on simple rules of thumb, rather than full-blown quantitative macroeconomic models. Although missing a lot of important ingredients, they illustrate some of the challenges that arise in much more sophisticated models. We begin with the influential formulation of Stanford professor John Taylor, whose simple “Taylor rule” for setting the policy interest rates worked surprisingly well for describing central bank behavior in many countries during the period of the Great Moderation (from the mid-1980s until the run-up to the 2008 financial crisis). Taylor’s 1993 formulation assumed equal weights on stabilizing inflation and output, with inflation deviations measured around a target level presumed to be 2%, and output deviations measured around potential output (loosely speaking, the rate of output consistent with full employment).4 When Taylor formulated his rule in the early 1990s, it seemed reasonable for him to build his approach on the assumption that a normal Federal Reserve overnight policy interest rate would be 4%.

Dale Henderson and Warwick McKibbin (1993) appear to have introduced the same idea as Taylor’s more or less simultaneously. 5. Beyond the choices discussed in the text (inflation index, potential output measure and relative weights on both), there are many other Taylor rule variants, for example, allowing for a more gradual adjustment of policy interest rates to target. In tranquil times, such as during the Great Moderation era of the late 1980s through the mid-2000s, these different variants of the rule give broadly similar messages. But when inflation and/or output go way off target, as especially was the case for output during the financial crisis of 2008, differences that had seemed second-order suddenly become very important, and the exact choice of rule starts to matter a lot more. In a deep output recession, with output far below its full employment trend level, the Yellen interpretation of the rule would call for much deeper interest rate cuts. 6.


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Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, New Journalism, oil shock, p-value, passive investing, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond

Disinflation and the Great Moderation I discuss inflation developments in greater detail in Chapter 17. Here I just remind readers of the mountain shape in postwar U.S. inflation data: an uptrend in the 1960s and 1970s and a downtrend in the 1980s and 1990s (see Figure 27.1). Importantly, many real-economy series and asset return series seem to have shared—or, rather, mirrored—these trends. Many benign developments—lower volatility, stronger real economy and corporate performance, and higher asset valuations—since the early 1980s may be traced back to disinflation, just as many of the malign developments before that may be attributed to soaring inflation and nominal interest rates. Disinflation since 1980 coincided with a decline in macroeconomic volatility (the Great Moderation) and, to a much lesser extent, in financial market volatility (see Figure 27.2).

Sometimes other aspects of financial crises—a bond or housing market selloff, vanishing liquidity, de-leveraging spirals, a breakdown in financial intermediation, spiking volatility, high correlations that limit diversification—boost MU even when stock markets are relatively stable. • The worst times are characterized by both financial and economic turbulence. Table 5.1 lists some periods that, in Justice Stewart’s spirit, were manifestly bad times. One might formalize the definition but there is no (academic or practitioner) consensus on how to do this. All 20th-century recessions could qualify but the period of the Great Moderation was characterized by the absence of severe economic downturns and, instead, an abundance of periodic financial crises. The last two rows highlight episodes where major financial turmoil triggered depression fears—echoes of 1929—but Fed easing and/or bailouts saved the system yet again (and over time gave rise to ever greater risk taking). Table 5.1. Prototypical bad times—both real economy and financial markets suffer Sources: Bloomberg, Haver Analytics, Ken French’s website.

They too assume a typical degree of loss aversion (just above 2) but find that a model with constant loss aversion cannot fully explain the equity premium puzzle. However, they can resolve the puzzle if they include in their model the “house money effect”—the idea that the degree of loss aversion varies dynamically with prior gains and losses. The model thus implies that investors’ risk attitudes become more conservative in down-markets. The next section shows that estimates of the equity premium have edged lower since the 1990s. During the Great Moderation years, it was popular to argue that lower macro-volatility and investor learning about equities’ long-run return advantage could justify a sustained fall in the required equity premium. Such arguments ring hollow after the 2008 experience. Yet, it remains plausible that the fair premium has declined somewhat due to lower trading costs and better global diversification opportunities. 8.3 HISTORICAL EQUITY PREMIUM Table 8.1 and Figure 8.1 recap the U.S. experience since the 19th century, documenting compound (geometric) nominal and real returns as well as equity premia over cash (mainly one-month Treasury bills) and over bonds (mainly 10-year Treasury bonds).


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, moral hazard, mortgage debt, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

Although there were many signs of future instability for those who cared to look, it is hard to overstate the complacency that characterised the period from the bursting of the internet bubble to the global financial crisis. The Nobel Prize-winning economist Robert Lucas told the annual meeting of the American Economic Association that the ‘central problem of depression prevention has essentially been solved’.24 Another academic economist, Ben Bernanke, who had been appointed to the Board of the Federal Reserve System, popularised the phrase ‘the Great Moderation’25 to describe a supposed new era of economic stability. In retrospect, the critical development during this period was the growth in trade in asset-backed securities, especially mortgage-backed securities, and subsequently collateralised debt obligations, between financial institutions. A false belief in the security provided by such packaging stimulated demand for these assets. Further reassurance appeared to be provided by the development of a market in credit default swaps – derivative securities that would pay out if there was default on the underlying security.

The following year, another Federal Reserve Board governor, Ben Bernanke, reiterated Kohn’s claim: ‘Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks.’ Such advances resulted, he said, in ‘greater resilience of the banking system’.5 Bernanke was the Princeton professor and student of the Great Depression who had earlier proclaimed ‘the Great Moderation’. The chairman of the Federal Reserve Bank of New York similarly applauded the work of risk managers when he addressed their annual conference. Timothy Geithner told his audience: Financial institutions are able to measure and manage risk much more effectively. Risks are spread more widely, across a more diverse group of financial intermediaries, within and across countries. These changes have contributed to a substantial improvement in the financial strength of the core financial intermediaries and in the overall flexibility and resilience of the financial system in the United States.6 The breathtaking scale of these misapprehensions proved no obstacle to the subsequent advancement of those who held them.

Leverage has been central to almost every modern financial crisis. The use of leverage can promote efficiency by enabling risk to be held and managed more efficiently. But the use of leverage provides opportunities for tailgaters and gamblers with other people’s money, and creates many opportunities to fall victim to the winner’s curse. And these opportunities were exploited to the full during the ‘Great Moderation’. By the time of the global financial crisis, Deutsche Bank had liabilities more than fifty times its equity capital – and, as I shall describe in Chapter 6, even this calculation underestimates the extent of leverage. What did Bernanke, Greenspan, Geithner and others think was really going on, as risk built up in the banking system? Perhaps Upton Sinclair had provided the answer: it was more convenient, politically and ideologically, not to look or analyse too closely.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

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asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, liquidity trap, London Interbank Offered Rate, margin call, market clearing, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Plutocrats, plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

Nobody could really ask if they were proper or necessary because of the record of success. Over time, the Great Moderation began to take the fear out of the equation for financial market players. That left only greed. The Natural History of Financial Folly BANKERS GONE WILD If there is one constant that runs through the work of Walter Bagehot it is that banking is a simple business that needs to follow simple rules. Innovation usually amounts to forgetting the rules (or having never learned them) and always ends up in tears. For this reason, he felt that dull, and even stupid men, were far better bankers than people who were clever. The decline of wholesome fear during the Great Moderation was probably not enough to turn credit from the wholesome lifeblood of an economy into a pathogen. A panic within the financial markets as they existed in 1982, if based on overconfidence built up over 25 years, would be pretty nasty.

WHY THINGS ARE WORSE THIS TIME The global financial market collapse that started in 2008 is vastly larger in scale and scope and has progressed with far greater speed than even the legendary crash of 1929. The depths and duration of the damage inflicted on the global economy may well be 139 140 FINANCIAL MARKET MELTDOWN substantially worse than the results of that earlier event for one simple reason: For over a generation, we have refused to let market busts play themselves out. This has been called the ‘‘Great Moderation.’’ Between 1982, when the ruinous inflation set off by the Great Society and Vietnam War spending of Lyndon Johnson in the late sixties had finally been broken by Paul Volcker’s Federal Reserve, and the credit market crisis of the summer of 2008, the global financial markets went from strength to strength for a quarter century. Not that there were not crises—there were, including whoppers like the U.S.


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Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, merger arbitrage, Mikhail Gorbachev, Milgram experiment, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Naomi Klein, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, pets.com, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond

Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”31 The audience sat in the manner of sinners, heads slightly bowed and the eyes moist and a bit glassy, amid the murmurs of “Amen, Brother” and “Praise the Lord.” Unstable Stability? Friedmanites argued that Reagan and Thatcher’s policies reinvigorated the economy, paving the way for the Great Moderation. Coined by Harvard economist James Stock, the term referred to an era of strong economic growth, increased prosperity, and the perceived end to economic cycles and volatility. Prosperity was increasingly based on financial services and the speculation economy. The cycles were still there, papered over by the free money from central banks when necessary. Speculation and risk-taking behavior were almost risk free, as long as everybody, especially large, too-big-to-fail institutions, bet on the same color.

Minsky viewed modern financial markets as “conditionally coherent” and characterized by “periods of tranquility.” Excessive risk taking—driven in part by assumptions about the level of risk, inherent investment biases as asset prices increase, and increased leverage—led to market breakdowns. Minsky’s caution about “balance sheet adventuring” presciently anticipated the crisis that was to bring the Great Moderation to its end in 2007. Ben Bernanke, a follower of Friedman and student of the Great Depression, found himself facing the type of crash that the theory said could not happen again. 8. False Gods, Fake Prophecies Finance is what economists call money; financial economics is the economics of money. Its pioneering scholars emanated from Chicago’s Graduate Business School (GBS) rather than the economics department because business schools paid better.

Alan Greenspan theorized that “a rising, debt-to-income ratio for households or of total non-financial debt to GDP” did not signify stress but was “a reflection of dispersion of a growing financial imbalance of economic entities that in turn reflects the irreversible up-drift in division of labor and specialization.”4 In 2005, Ben Bernanke, Greenspan’s successor as chairman of the US Federal Reserve, provided an apology for high levels of debt: “Concerns about debt should be allayed by the fact that household assets (particularly housing wealth) have risen even more quickly than household liabilities.”5 In the Great Moderation, debt-driven speculation drove prosperity. For Bernanke, it was not even a debt problem but a savings problem. He blamed the Germans, Japanese and Chinese for saving too much.6 America was being “neighborly,” helping out. After the global crisis, in a case of severe cognitive dissonance, Bernanke continued to blame the foreign savers for the problems.7 In 1933, the economist Irving Fisher identified the danger: “over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.”8 In 2005, William White, chief economist at the Bank of International Settlement, broke ranks by warning that easy money was creating a boom that would end painfully, reflecting “the size of the real imbalances that, preceded it.”


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Capitalism: Money, Morals and Markets by John Plender

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Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, labour market flexibility, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, means of production, Menlo Park, moral hazard, moveable type in China, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, We are the 99%, Wolfgang Streeck

He was convinced that the market process was so benign – ‘efficient’, in economists’ argot – that supervision was a waste of time. At the Bank of England, Mervyn (now Lord) King was notoriously uninterested in financial stability issues before the crisis. In the period ineptly dubbed ‘the Great Moderation’, central bankers were prone to think that if inflation was kept within target, the financial system would look after itself.44 They also claimed credit for this apparent stability. In 2004, Ben Bernanke, governor of the Fed and later its chairman, said: ‘My view is that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation.’45 This plaudit for central bankers included by implication a pat on the back for Bernanke himself. The approach to central banking outlined here was in marked contrast to the days before academics and professional economists took over from banking practitioners at the head of leading central banks.

Robert Lucas, doyen of modern macro-economics, has defended mainstream economists for their failure to foresee the crisis, arguing that economic theory predicts that these events cannot be predicted. This side-stepping apologia does not say much for economic theory and there are more salient reasons, which I will come to shortly, that explain why the great majority of mainstream practitioners of economics failed to understand the mechanisms that put the global economy at risk. Such people referred to the period preceding the crisis as ‘the Great Moderation’ because it was marked by prolonged growth and low inflation. At the same time, Lucas has acknowledged that ‘exceptions and anomalies’ to the efficient markets hypothesis have been discovered, ‘but for the purposes of macro-economic analyses and forecasts they are too small to matter’.90 John Kay’s verdict on this is scathing: This is to miss the point: the expert billiard player plays a nearly perfect game, but it is the imperfections of play between experts that determine the result.


pages: 370 words: 102,823

Rethinking Capitalism: Economics and Policy for Sustainable and Inclusive Growth by Michael Jacobs, Mariana Mazzucato

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3D printing, balance sheet recession, banking crisis, Bernie Sanders, Bretton Woods, business climate, Carmen Reinhart, central bank independence, collaborative economy, complexity theory, conceptual framework, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, decarbonisation, deindustrialization, dematerialisation, Detroit bankruptcy, double entry bookkeeping, Elon Musk, energy security, eurozone crisis, factory automation, facts on the ground, fiat currency, Financial Instability Hypothesis, financial intermediation, forward guidance, full employment, Gini coefficient, Growth in a Time of Debt, Hyman Minsky, income inequality, Internet of things, investor state dispute settlement, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, low skilled workers, Martin Wolf, Mont Pelerin Society, neoliberal agenda, Network effects, new economy, non-tariff barriers, paradox of thrift, price stability, private sector deleveraging, quantitative easing, QWERTY keyboard, railway mania, rent-seeking, road to serfdom, savings glut, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Steve Jobs, the built environment, The Great Moderation, The Spirit Level, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, trickle-down economics, universal basic income, very high income

In the US, Fed Chairman Ben Bernanke described the apparent decline in macroeconomic volatility as the ‘Great Moderation’. In Bernanke’s view, it was largely due to the introduction of a successful monetary policy framework focused on ensuring price stability.29 In Britain, Chancellor of the Exchequer, and later Prime Minister, Gordon Brown declared that the Labour government (1997–2010) had aimed to avoid returning to the ‘boom and bust’ of previous eras. His confidence stemmed from his early decision to grant operational independence to the Bank of England in the conduct of a monetary policy. In his initial letter to the Bank of England, Brown wrote: ‘price stability is a precondition for high and stable levels of growth and employment, which in turn will create the conditions for price stability on a sustainable basis.’30 But the Great Moderation thesis was blown away by the global financial crisis.

De Grauwe, ‘Economic theories that influenced the judges of Karlsruhe’, Vox, 13 March 2014, http://www.voxeu.org/article/economic-flaws-german-court-decision (accessed 19 April 2016). 27 ECB, Asset Purchase Programmes, https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html (accessed 19 April 2016). 28 D. Papadimitriou and L. Randall Wray, Euroland’s Original Sin, Levy Economics Institute Policy Note 2012/8, 2012. 29 B. S. Bernanke, The Great Moderation, Federal Reserve Board, 2004, http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/ (accessed 19 April 2016). 30 G. Brown, The New Monetary Policy Framework, 1997, http://www.bankofengland.co.uk/monetarypolicy/Documents/pdf/chancellorletter970506.pdf (accessed 19 April 2016). 4. The Costs of Short-termism1 ANDREW G. HALDANE Introduction IS THE world becoming short-sighted?


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Panderer to Power by Frederick Sheehan

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Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, Long Term Capital Management, margin call, market bubble, McMansion, Menlo Park, mortgage debt, new economy, Northern Rock, oil shock, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War

Of course, increased rates of homeownership and household consumption are both good things.”11 Even today, Bernanke’s economics remain uncluttered with the possibility of too much debt. He is still a gung-ho apostle of renewing economic growth through consumer borrowing and spending. 10 Richebächer Letter, March 2006, p. 10. 11 Ben S. Bernanke, “Global Savings Glut and the U.S. Current Account Deficit,” Homer Jones Lecture, St. Louis, Missouri, April 14, 2005. Before his chairmanship, he gave a speech entitled “The Great Moderation.” In that 2004 address, Bernanke offered interpretations of the “remarkable decline in the variability of both output and inflation” over the past two decades. He permitted the possibility that structural changes to the economy and luck may have played their role, but left no doubt that “improved performance of macroeconomic policies, particularly monetary policy” should receive the Nobel Prize.12 [Bernanke’s italics].

He was blind to the financial mayhem that accompanied his economic moderation. In 2008, researchers at the International Monetary Fund (IMF) identified 124 international banking crises since 1970. Four were in the 1970s, 39 were in the 1980s, 74 were in the 1990s, and 7 were after the millennium.13 The current worldwide banking crisis is not included. It would be premature to quantify it. The Great Moderation was, in fact, the Great Distortion. The Peak We now know that the housing bubble peaked sometime in 2005 or early 2006. Ben S. Bernanke was sworn in as Federal Reserve chairman on February 1, 2006. The brightest guys in the room thought that the excesses were about to collapse. Sam Zell, owner of Equity Office Properties, offered his opinion: “The enormous monetization of hard assets has created a massive amount of liquidity.… Together with [the rising demand for income in the developed world], these factors … are reducing the relative expectations on equity.”14 Another who saw the sun setting was Stephen Schwartzman, head of Blackstone Group, perhaps the premier buyout firm over the past two decades.

.… Together with [the rising demand for income in the developed world], these factors … are reducing the relative expectations on equity.”14 Another who saw the sun setting was Stephen Schwartzman, head of Blackstone Group, perhaps the premier buyout firm over the past two decades. He told an audience: “We have low [interest] rates, tons of money in both the private equity and debt markets.… But when it ends, it always ends badly. One of those signs is when the dummies can get money and that’s where we are now.”15 12 Ben Bernanke, “The Great Moderation,” speech at the meetings of the Eastern Economic Association, Washington, D.C., February 20, 2004. 13Luc Laeven and Fabian Valencia, “Systemic Banking Crises: A New Database,” IMF, October 2008, p. 56. 14From Sam Zell’s 2005 electronic Christmas card, “The Theory of Relativity,” www. yieldsz.com; quoted in Ted Pincus, “Zell Remains Relaxed about Economy as Others Fret,” Chicago Sun-Times, September 12, 2006.


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The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

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airport security, availability heuristic, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

This particularly holds in the period between 1983 and 2006—a subset of the Long Boom that is sometimes called the Great Moderation—when the economy was in recession just 3 percent of the time. But much of the growth was fueled by large increases in government and consumer debt, as well as by various asset-price bubbles. Advanced economies have no divine right to grow at Great Moderation rates: Japan’s, which grew at 5 percent annually during the 1980s, has grown by barely one percent per year since then.43 This may be one reason why forecasters and policy makers were taken so much by surprise by the depth of the 2007 recession. Not only were they failing to account for events like the Great Depression*—they were sometimes calibrating their forecasts according to the Great Moderation years, which were an outlier, historically speaking. Don’t Throw Out Data The Federal Open Market Committee, which is charged with setting interest rates, is required by law to release macroeconomic forecasts to Congress at least twice per year.

But they were not betting on a recession (their forecast still projected growth), and there was little indication that they were entertaining the possibility of as severe a recession as actually unfolded. Part of the reason may have been that the Fed was looking at data from the Great Moderation years to set their expectations for the accuracy of their forecasts. In particular, they relied heavily upon a paper that looked at how economic forecasts had performed from 1986 through 2006.45 The problem with looking at only these years is that they contained very little economic volatility: just two relatively mild recessions in 1990–1991 and in 2001. “By gauging current uncertainty with data from the mid-1980s on,” the authors warned, “we are implicitly assuming that the calm conditions since the Great Moderation will persist into the future.” This was an awfully big assumption to make. The Fed may have concluded that a severe recession was unlikely in 2007 in part because they had chosen to ignore years in which there were severe recessions.


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Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

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accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, market bubble, Martin Wolf, medical malpractice, microcredit, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

Finally, and most important, the persistent and politically motivated monetary stimulus that accompanies discretionary fiscal stimulus is, if anything, even more dangerous for the long-term health of the U.S. economy, and indeed the world, for it affects the behavior of the financial sector. I turn to that fault line now. CHAPTER FIVE From Bubble to Bubble NO CENTRAL BANKER HAS HAD to adapt his views more under the public eye than Ben Bernanke, the chairman of the Federal Reserve Board. In February 2004, in a speech to the Eastern Economic Association, Bernanke, then a governor of the Federal Reserve Board, spoke of the “Great Moderation,” the observation that the fluctuations of output and inflation in industrial countries had come down steadily since the mid-1980s. Because the Holy Grail of economic management is strong, steady growth, without booms, busts, or high inflation, this trend suggested that something was working. Bernanke considered three possible explanations: first, that we might have just been lucky, with the world economy experiencing fewer accidents such as war and oil-price increases over this period.

The representative-agent models were easy to work with and did offer useful predictions about policy, but they took for granted the plumbing underlying the industrial economy—the financial claims, the transactions, the incentive structures, the firms, the banks, the markets, the regulations, and so on. So long as these mechanisms worked well, the models were a useful simplification. And during much of the “Great Moderation” that Bernanke referred to, the plumbing worked well and served as a good basis for abstract reasoning. But as soon as the plumbing broke down, the models were an oversimplification. Indeed, the models themselves may have hastened the plumbing’s breakdown: with the Fed focused on what interest rates would do to output rather than to financial risk taking (few models had a financial sector embedded in them, let alone banks), financial risk taking went unchecked.


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The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

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banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business process, call centre, capital controls, collective bargaining, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, Long Term Capital Management, low skilled workers, manufacturing employment, market bubble, Martin Wolf, mittelstand, mobile money, Mont Pelerin Society, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

‘The central problem of depression-prevention’, he momentously explained to his audience, ‘has been solved, for all practical purposes.’ By this he did not mean that the economic cycle had disappeared, or the economy would not suffer occasional setbacks, just that the days of severe recession were over and that economic fine-tuning was of no value. A year later, in February 2004, Ben Bernanke, a former Princeton Professor and soon to be appointed Chairman of the Federal Reserve, gave a speech called ‘The Great Moderation’, that made a similar point. Bernanke claimed that because of the apparent decline in the variability of both output and inflation from the mid-1980s, modern macroeconomics had largely solved the problem of the business cycle. According to these accounts, from two of the leading economic theorists in the US, the disaster of 2008-2009 should not have happened. So what about the record of the thirty-year long era of market economics?

‘Banks devised a host of new tricks for offering investors better returns’, according to the Financial Times’s Gillian Tett, and a leading expert on derivatives, ‘which invariably revolved around creating products that employed more leverage, as well as more complexity and risk.’383 For a while, the derivatives market was highly lucrative for the investment banks issuing them and the institutions buying them. In the heady days of the ‘great moderation’, when economies and markets were booming, derivatives provided apparently easy money for bankers, financiers and wealthy investors. The products were marketed by banks to clients as a way of boosting their wealth. Again, incentives were being distorted by the prospect of enrichment. The whole business became deliberately clouded in complexity and opacity, eluding even those charged with controlling the process.


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Washington Consensus, working-age population, World Values Survey

There were serious discussions about the need to reform the global financial system, much of them along the same lines as the ones that we have seen following the 2008 global financial crisis. Even many leading advocates of globalization – like the Financial Times columnist Martin Wolf and the free-trade economist Jagdish Bhagwati – started questioning the wisdom of allowing free international capital flows. All was not well with the new global economy. The false dawn: from the dot.com boom to the Great Moderation When these crises were brought under control, talk of global financial reform receded. In the US, a major push in the other direction came in the form of the 1999 repeal of the iconic New Deal legislation, the 1933 Glass-Steagall Act, which structurally separated commercial banking from investment banking. There was another moment of panic in 2000, when the so-called dot.com bubble – in which internet-based companies with no prospect of generating any profit in the foreseeable future had their shares valued at absurdly high levels – burst in the US.

From then on, the early years of the millennium seemed to be going swimmingly well in the rich countries, especially in the US. Growth was robust, if not exactly spectacular. Asset prices (prices of real estate, company shares and so on) seemed to be going up forever. Inflation remained low. Economists – including Ben Bernanke, the chairman of the Federal Reserve Board between February 2006 and January 2014 – talked of the ‘Great Moderation’, in which the science of economics had finally conquered boom and bust (or the economy going up and down by large margins). Alan Greenspan, the chairman of the Federal Reserve Board between August 1987 and January 2006, was revered as the ‘Maestro’ (as immortalized in the title of his biography by Bob Woodward of Watergate fame) who had a near-alchemical skill in managing a permanent economic boom without stoking inflation or courting financial trouble.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus

The “don’t bail them out” message taps into a strong current of populist American opinion.51 Meanwhile, the “don’t intervene/let it run its course” message found strong support in the right wing of the Republican Party and among elements of the financial community that were not too big to fail, particularly hedge funds.52 Why, then, apart from few key high-profile figures such as Glenn Beck, Peter Schiff, Ron Paul, and (the younger) Alan Greenspan, is it difficult to find mainstream economists, even in America, who publicly accept the Austrian theory of the business cycle? To see why, we need to look at the assets and liabilities side of the Austrian explanatory balance sheet. On the asset (theory) side, we find the action of central banks in producing asset bubbles with prolonged policies of too-cheap money and the epistemic hubris of managing the Great Moderation blowing up in the faces of the same central bankers who declared that they had tamed the cycle, which is not an unreasonable description of the 2000s. The broad sweep of an asset bubble’s inflation and deflation is well described by the basic Austrian model. The notion that debt is not simply redistributionary (my income is your debt) because leverage matters and that the payoff to debt financing is asymmetric, especially on the downside, is also a telling and important contribution.

David Simpson, “Joseph Schumpeter and the Austrian School of Economics,” Journal of Economic Studies 10, 4 (1983): 18–28. http://www.emeraldinsight.com/journals.htm?articleid=1709331. 41. Robinson, “Second Crisis,” 2. 42. Remember, in the Keynesian world, the point of spending money to stimulate the economy is not that money is causal per se. Rather, the point is to raise prices sufficiently to alter the expectations of investors, which in turn impacts employment and consumption. 43. Ben Bernanke, “The Great Moderation,” remarks at the meetings of the Eastern Economic Association, Washington DC, February 20, 2004. http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm. 44. The rate of interest on the loan is less than the rate of return on the asset given rising prices, but the more interest rates play catch up, the more the returns are squeezed. 45. Ludwig von Mises, “The Austrian Theory of the Trade Cycle,” in The Austrian Theory of the Trade Cycle and Other Essays, ed.


pages: 391 words: 102,301

Zero-Sum Future: American Power in an Age of Anxiety by Gideon Rachman

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Asian financial crisis, bank run, battle of ideas, Berlin Wall, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Bretton Woods, BRICs, capital controls, centre right, clean water, collapse of Lehman Brothers, colonial rule, currency manipulation / currency intervention, deindustrialization, Deng Xiaoping, Doha Development Round, energy security, failed state, Fall of the Berlin Wall, financial deregulation, Francis Fukuyama: the end of history, full employment, global reserve currency, greed is good, Hernando de Soto, illegal immigration, income inequality, invisible hand, Jeff Bezos, laissez-faire capitalism, market fundamentalism, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, moral hazard, mutually assured destruction, Naomi Klein, offshore financial centre, open borders, open economy, Peace of Westphalia, peak oil, pension reform, Plutocrats, plutocrats, price stability, RAND corporation, reserve currency, rising living standards, road to serfdom, Ronald Reagan, shareholder value, Sinatra Doctrine, sovereign wealth fund, special economic zone, Steve Jobs, Stewart Brand, The Chicago School, The Great Moderation, The Myth of the Rational Market, Thomas Malthus, trickle-down economics, Washington Consensus, Winter of Discontent

In India, Manmohan Singh, a distinguished academic economist, played a key part in the economic reforms, first as finance minister and then as prime minister. In Mexico, the North American free-trade agreement was negotiated in 1993 by Carlos Salinas, a president with a doctorate in economics from Harvard. The self-confidence of economics as a profession was also rising. In 2004, Ben Bernanke, who was to succeed Greenspan as chairman of the Fed in 2006, gave a speech on a phenomenon he called “the Great Moderation.” He drew attention to the “substantial decline in macroeconomic volatility” over the past twenty years, or, in noneconomist-speak, the emergence of a long, economic boom whose peaks and troughs were much less pronounced than those experienced in more turbulent economic times. Bernanke considered three possible explanations for this happy outcome: luck, structural factors, and better economic policy.

Richard Roberts and David Kynaston, City State: A Contemporary History of the City of London and How Money Triumphed (London: Profile, 2001), 33. 22. Quoted in “India’s booming economy,” Economist, March 2, 2006, 66. 23. Vince Cable, The Storm: The World Economic Crisis and What It Means (London: Atlantic Books, 2009), 90. 24. Derek Chollet and James Goldgeier, America Between the Wars: From 11/9 to 9/11 (New York: PublicAffairs, 2008), 289. 25. Ben Bernanke, “The Great Moderation,” remarks at the meeting of the Eastern Economic Association, Washington, D.C., February 20, 2004. The speech is available from www.federalreserve.gov/boarddocs/speeches/2004. 26. It would be nice to claim a direct correlation between my joining the paper and its subsequent phenomenal success. But circulation continued to rise steadily, even after the shock of my departure. 27. Michael Mandelbaum, The Ideas That Conquered the World: Peace, Democracy, and Free Markets in the Twenty-First Century (New York: PublicAffairs, 2002), 417. 28.

The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) by Feng Gu

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Affordable Care Act / Obamacare, barriers to entry, business process, Claude Shannon: information theory, Clayton Christensen, conceptual framework, corporate governance, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, double entry bookkeeping, Exxon Valdez, financial innovation, fixed income, hydraulic fracturing, index fund, inventory management, Joseph Schumpeter, knowledge economy, moral hazard, new economy, obamacare, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, race to the bottom, risk/return, Robert Shiller, Robert Shiller, shareholder value, Steve Jobs, The Great Moderation, value at risk

Commenting on the October 2014 market volatility (the S&P 500 decreased 6 percent in mid-October 2014, yet ended the month in record high), an opinion piece in the Wall Street Journal reminded readers: . . . the volatility in the macro (real) economy is very low. . . . [L]ooking back over the entire business cycle, the volatility of GDP growth during the past four years is comparable to the previous two business-cycle expansions. . . . To describe similar phenomena in the 1990s, about a decade ago economists coined the term the Great Moderation—and its back in use today.8 Thus, we experience a great moderation rather than rising turbulence. The volatility of the overall economy is, of course, a major determinant of business enterprises’ volatility. Economic lurches between boom and bust affect consumers’ demand, resource prices, and ultimately companies’ operations. So, what is the volatility record of the economy? In a word—it’s declining.

Most investors, however, cannot afford such costly research. 8. Jason Cummins, “Wall Street Volatility Doesn’t Shake Main Street,” The Wall Street Journal (December 1, 2014). 9. References for the research mentioned in this paragraph: Olivier Blanchard and Jon Simon, “The Long and Large Decline in U.S. Output Volatility,” Brookings Papers on Economic Activity, No. 1, Brookings Institution. Jason Furman, 2014, Whatever happened to the Great Moderation? Remarks at the 23rd annual Hyman P. Minsky Conference, April 10, 2001. 10. Specifically, for each company and year (say 1995), we measure volatility by the standard deviation of its sales-to-total-assets ratio (to account for the different sizes of companies) over the previous five years (1991−1995, in our example). We then average those standard deviations (volatility) over the 1,000 companies in our sample for that year.


pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

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accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, Mont Pelerin Society, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, oil shock, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

There has been so much corroborating research of Blinder’s claim that the issue has been fairly settled. Still, even Democrats adopted Friedman’s natural unemployment rate hypothesis. Friedman turned the attention of the nation’s policymakers to keeping inflation low and it became an unchallenged priority for them. Many economists hailed the resulting low inflation that began in the 1990s as the beginning of a new stable age of ideal growth—which became known as the Great Moderation. Much the opposite is more likely. The anti-inflationary policies were adhered to too firmly, and contributed significantly to slower rates of growth, higher levels of unemployment, the disappointing growth rate of productivity until the late 1990s, and stagnating wages. Extreme speculative excesses arose in other areas while Friedman’s anti-inflation heirs were in charge—in high-technology stocks in the late 1990s and mortgage finance in the 2000s, to take but the starkest examples.

There had been dissenters among mainstream economists who thought the inflation target was too low, but their advice went untaken by those running policy. By 2010, this was changing. Economists at the International Monetary Fund, for example, suggested the annual target for inflation could be raised from 2 percent to 4 percent. “Nobody knows the cost of inflation between 2 and 4 percent,” wrote the IMF chief economist and former MIT professor Olivier Blanchard, who once fully expressed his faith in the benefits of the Great Moderation. “So I think people could get used to 4 percent and the distortions would be small.” In 1980, the Friedmans published a simple version of Capitalism and Freedom called Free to Choose, which was the basis of a public television series. By then he was internationally known and respected and his criticism of government was carried across the world. But Friedman, who claimed he was an empirical economist, never developed a political or moral philosophy.

.: Princeton University Press, 2000). 56 THE MONETARY HISTORY, THEY WROTE: Hirsch and De Marchi, Milton Friedman, p. 264. 57 EVEN HE EVENTUALLY ALLOWED: Milton Friedman, “Perspective on Inflation,” Newsweek, June 1974. 58 “THE GREAT INFLATION OF 1973–74”: Alan S. Blinder, Economic Policy and the Great Stagflation (New York: Academic Press, 1979), p. 103. 59 THERE HAS BEEN SO MUCH CORROBORATING RESEARCH: Alan S. Blinder and Jeremy B. Rudd, “The Supply Shock Explanation of the Great Stagflation Revisited,” Center for Economic Studies Working Paper, No. 176, Princeton, November 2008, p. 49. 60 MANY ECONOMISTS HAILED: Ben S. Bernanke, “The Great Moderation,” Speech, February 2004, http://www.bis.org/review/r040301f.pdf. 61 THERE HAD BEEN DISSENTERS: George A. Akerlof, William T. Dickens, and George L. Perry, “Near-Rational Wage and Price Setting and the Optimal Rates of Inflation and Unemployment,” Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31 (2000–2001), pp. 1–60. 62 “NOBODY KNOWS THE COST”: On Blanchard’s inflation targeting, see Chris Giles, “IMF Experts Spell Out Policy Flaws,” Financial Times, February 12, 2010, p. 3; Akerlof, Dickens, and Perry, “Near-Rational Wage and Price Setting and the Optimal Rates of Inflation and Unemployment,” p. 1. 63 RATHER, HIS SOCIAL POLICY WAS DRIVEN: Friedman, Capitalism and Freedom, p. 169. 64 “THE GREAT ADVANCES OF CIVILIZATION”: Ibid., p. 5. 65 “THE GREAT ACHIEVEMENT OF CAPITALISM”: Ibid., p. 169. 66 “I HAVE ALWAYS BEEN IMPRESSED”: Friedman and Friedman, Two Lucky People, pp. 217–18.


pages: 710 words: 164,527

The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order by Benn Steil

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Albert Einstein, Asian financial crisis, banks create money, Bretton Woods, British Empire, capital controls, currency manipulation / currency intervention, currency peg, deindustrialization, European colonialism, facts on the ground, fiat currency, financial independence, floating exchange rates, full employment, global reserve currency, imperial preference, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Rogoff, margin call, means of production, money: store of value / unit of account / medium of exchange, Monroe Doctrine, New Journalism, open economy, Potemkin village, price mechanism, price stability, psychological pricing, reserve currency, road to serfdom, seigniorage, South China Sea, special drawing rights, The Great Moderation, the market place, trade liberalization, Works Progress Administration

Inflation fell rapidly, down to an annualized 3.2 percent in 1983, a rate around which it began to stabilize, while economic growth resumed and jobs returned. Ultimate vindication would appear to have come in the form of the subsequent near-quarter-century stretch of relatively stable growth, underpinned by the Fed’s mastery of consumer price inflation, mainly under the tutelage of Alan Greenspan. A new age, dubbed “the Great Moderation,” was declared by Green-span’s successor, Ben Bernanke, and others.31 Harry White, it seemed, was wrong about gold; it was indeed, by all appearances, the barbarous relic that Keynes had tried to excise from man’s monetary consciousness. Over the course of the 1990s, the world’s central banks sold off large stocks of the relic, helping to drive its price down to $290 an ounce at the end of the millennium.

Brazilian Finance Minister Guido Mantega grabbed the headlines in September 2010 when he declared that “an international currency war” had broken out, with countries, most notably the United States, deliberately seeking to push down their currencies to boost exports and discourage imports in the midst of a severe economic slowdown. Switzerland, Japan, Brazil, and others intervened in the foreign exchange markets to counter what they saw as unacceptable upward pressure on their currencies. Though Mantega’s observation may have been hyperbolic, its widespread repetition reflected a palpable growing sense in the markets that dangers lay in the passing of the Great Moderation. Though the benign scenario of a gentle transition from a dollar-dominated world to one in which other developed and emerging market currencies play a much larger international role is plausible, precedent is lacking. When the dollar, pound, franc, and mark each played a reserve role in the early twentieth century, they were each surrogates for gold. When the dollar and pound shared reserve status in the middle of that century, the pound was largely inconvertible, and had mainly a captive clientele.

In The State and Economic Knowledge: The American and British Experience, ed. Mary Furner and Barry Supple. Cambridge: Cambridge University Press. Bareau, Paul. 1951. “Anglo-American Financial Relations during and since the War.” Four lectures delivered at the London School of Economics. In the possession of Peter Bareau. Bentley, Elizabeth. 1951 [1988]. Out of Bondage: The Story of Elizabeth Bentley. New York: Ballantine. Bernanke, Ben S. Feb. 20, 2004. “The Great Moderation.” Remarks by Governor Ben S. Bernanke at the meetings of the Easter Economic Association, Washington, D.C. Biographical Directory of the United States Congress. “Wolcott, Jesse Paine (1893–1969).” Available at http://bioguide.congress.gov/scripts/biodisplay.pl?index=W000668. Black, Conrad. 2003. Franklin Delano Roosevelt: Champion of Freedom. New York: PublicAffairs. Black, Stanley W. 1991.


pages: 457 words: 128,838

The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Paul Vigna, Michael J. Casey

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3D printing, Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, Internet of things, inventory management, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, underbanked, WikiLeaks, Y Combinator, Y2K, Zimmermann PGP

Memories of that period, where inflation drastically eroded the value of the dollars in people’s pockets and then forced them into a painful economic contraction, are still so strong among a certain generation that they feed the appeal of scarce, independent “currencies” such as gold and, as we shall see, bitcoin. After Volcker’s tough love, things improved enormously, at least for a time. A period known as the Great Moderation set in for industrialized countries, with low, predictable inflation and steady growth marred only by the occasional, short-lived recession. Europe embarked on a truly bold new experiment to create a currency union, one that for the first ten years of its existence seemed to be a rip-roaring success, as the euro miraculously conveyed Germany’s sound credit rating to once backwater countries such as Ireland and Spain, which enjoyed a tremendous influx of capital and an unprecedented housing boom.

As if learning from the Renaissance merchant bankers, Wall Street had again found an effective way to take sovereign money and multiply it many times over through a form of private money built on debt. But it was happening in an area that was far more thinly regulated than the traditional banking system. When it finally dawned on people how important this shadow system was, it was too late. With the collapse of Lehman Brothers, this fragile edifice came tumbling down. The Great Moderation had carried a curse. Not only did it foster a false sense of security, but also it caused us to forget our responsibilities as a society to use our political process to change unwelcome economic circumstances. Everyone from voters to Wall Street traders to congressmen to the president wanted to believe the financial system could be left in the hands of the Fed. The highly respected Paul Volcker gave way to the “maestro,” Alan Greenspan, who was equally revered, until he wasn’t.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund

“Despite the stock market plunge, terrorist attacks, corporate scandals, and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession—even milder than that of a decade earlier.” A month later, Ben Bernanke, who was then a Fed governor, gave Greenspan and himself another pat on the back, arguing that “improvements in monetary policy” had been an important source of the extended period of relative economic calm dating back to the 1980s, which economists referred to as the Great Moderation. Bernanke said he was “optimistic for the future” because policymakers were unlikely to forget the lessons they had learned. In reality, the Fed, by keeping interest rates artificially low, was in the process of substituting one bubble for another. John B. Taylor, a well-known Stanford economist, has put forward a simple equation that shows what interest rate the Fed should set depending on the level of inflation and unemployment.

Banks put many subprime securities on their books. Banks hold less capital and lever up their balance sheets. Credit Rating Agencies Paid by issuers. Generous fees. Most subprime securities rated “AAA” or “AA.” Hedge Funds/Sovereign Wealth Funds/Mutual Funds Ultralow interest rates. Investment-grade ratings for subprime securities. Search for “yield.” Heavy demand for subprime securities. Regulators/Policymakers “The Great Moderation.” Low inflation. Illusion of harmony/Illusion of stability. Disaster myopia. Interest rates too low. Deregulation pressed too far. What the table doesn’t show is how the various incentive problems aggravated and reinforced one another. At any one point in time, incentives can get distorted in a particular market. But the memory of past busts, together with financial regulations and restrictive social conventions, usually preserve a modicum of stability.


pages: 411 words: 114,717

Breakout Nations: In Pursuit of the Next Economic Miracles by Ruchir Sharma

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3D printing, affirmative action, Albert Einstein, American energy revolution, anti-communist, Asian financial crisis, banking crisis, Berlin Wall, BRICs, British Empire, business climate, business process, business process outsourcing, call centre, capital controls, Carmen Reinhart, central bank independence, centre right, cloud computing, collective bargaining, colonial rule, corporate governance, crony capitalism, deindustrialization, demographic dividend, Deng Xiaoping, eurozone crisis, Gini coefficient, global supply chain, housing crisis, income inequality, indoor plumbing, inflation targeting, informal economy, Kenneth Rogoff, knowledge economy, labor-force participation, labour market flexibility, land reform, M-Pesa, Mahatma Gandhi, market bubble, megacity, Mexican peso crisis / tequila crisis, new economy, oil shale / tar sands, oil shock, open economy, Peter Thiel, planetary scale, quantitative easing, reserve currency, Robert Gordon, Shenzhen was a fishing village, Silicon Valley, software is eating the world, sovereign wealth fund, The Great Moderation, Thomas L Friedman, trade liberalization, Watson beat the top human players on Jeopardy!, working-age population

And the two recessions saw economic output fall barely 1 percent over two quarters, much less painful than the prior average of 2.5 percent stretched over five quarters. The data for the rest of the world are sketchier but similar. Since the early 1980s in the developing nations, the economic cycle of recovery and recession has typically run for around eight years, double the historical average of four years. In the United States the flattening of the business cycle came to be known as “the Great Moderation,” and at its peak, debate raged about whether this comfortable new environment was here to stay. The agony of 2008 ended that wishful discussion. Before the crisis, recessions had moderated in depth and length, due in large part to the almost limitless ability of the United States to fund growth by borrowing, mainly from the rest of the world. Globalization was forcing companies to become more productive, producing more for less and lowering the threat of inflation.

The increasing integration of global supply chains is a major reason why developed and developing economies began to expand and contract in sync over the last decade. It is also why emerging markets, too, can expect a shift to more frequent downturns. If the historical record cited above is any guide, the expansion phases are likely to shorten by a half or more to around three years across the global economy. The Upside of Hard Landings Volatility may be scary, but it is not necessarily bad for long-term growth. The Great Moderation of recent decades did nothing to increase the long-term growth rate of the United States, nor did the sharp booms and busts of the late nineteenth century do anything to slow the overall explosion of U.S. economic growth. What we have often seen is that nations with the wherewithal to pay for a soft landing out of recession frequently end up sinking in this expensive pillow. This deep preference for soft landings is understandable, but it is equally clear that hard landings often force reforms that set the stage for rapid growth.


pages: 248 words: 57,419

The New Depression: The Breakdown of the Paper Money Economy by Richard Duncan

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asset-backed security, bank run, banking crisis, banks create money, Ben Bernanke: helicopter money, Bretton Woods, currency manipulation / currency intervention, debt deflation, deindustrialization, diversification, diversified portfolio, fiat currency, financial innovation, Flash crash, Fractional reserve banking, income inequality, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, money: store of value / unit of account / medium of exchange, mortgage debt, private sector deleveraging, quantitative easing, reserve currency, Ronald Reagan, savings glut, special drawing rights, The Great Moderation, too big to fail, trade liberalization

Over the following decades, the expansion of trade—and trade deficits—with low-wage countries such as China created strong disinflationary pressures in the United States, despite the extraordinary expansion of fiat money-denominated credit that was occurring there at that time. Rising debt drove the U.S. economy and created employment by pushing up asset prices, but consumer price inflation remained low as an increasing share of the goods sold in the country was made with $5 per day labor. The U.S. trade deficit reached 6 percent of GDP in 2006. The Fed likes to take credit for the “Great Moderation” in inflation during recent decades. But monetary policy had very little to do with it. The disinflation was the result of a collapse in the marginal cost of labor. Thus, it was an unprecedented combination of events—fiat money, technological advances in transportation and communications, large global trade imbalances, and cross-border capital flows—that permitted the truly extraordinary expansion of credit that has occurred in the Unites States since the early 1980s.


pages: 278 words: 82,069

Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover by Katrina Vanden Heuvel, William Greider

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Asian financial crisis, banking crisis, Bretton Woods, capital controls, carried interest, central bank independence, centre right, collateralized debt obligation, conceptual framework, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, declining real wages, deindustrialization, Exxon Valdez, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, full employment, housing crisis, Howard Zinn, Hyman Minsky, income inequality, kremlinology, Long Term Capital Management, margin call, market bubble, market fundamentalism, McMansion, mortgage debt, Naomi Klein, new economy, offshore financial centre, payday loans, pets.com, Plutocrats, plutocrats, Ponzi scheme, price stability, pushing on a string, race to the bottom, Ralph Nader, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, sovereign wealth fund, structural adjustment programs, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, wage slave, Washington Consensus, women in the workforce, working poor, Y2K

Greenspan resolved the tension easily (as most conservatives probably would) by tipping the scales in favor of sound money. The strategy produced very low price inflation, as close to zero as possible, which boosted prices for financial assets, stocks and bonds but also pumped up the financial bubble even further. Soaring stocks encouraged “New Economy” fantasies that the good times would last forever. His fans call Greenspan’s era “the great moderation” because there were fewer and shorter recessions, but that leaves out the deeper-running consequences of his reign. In reality the Fed was acting as a principal source of the growing inequalities in American society. Greenspan’s ultimate dilemma—his essential governing failure—was that he didn’t know how to handle “success.” He had pushed too far in one direction, hardening money’s value year after year, but he couldn’t push price levels any lower without igniting a destructive deflationary spiral.


pages: 204 words: 67,922

Elsewhere, U.S.A: How We Got From the Company Man, Family Dinners, and the Affluent Society to the Home Office, BlackBerry Moms,and Economic Anxiety by Dalton Conley

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3D printing, call centre, clean water, dematerialisation, demographic transition, Edward Glaeser, extreme commuting, feminist movement, financial independence, Firefox, Frank Levy and Richard Murnane: The New Division of Labor, Home mortgage interest deduction, income inequality, informal economy, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, knowledge economy, knowledge worker, labor-force participation, late capitalism, low skilled workers, manufacturing employment, McMansion, mortgage tax deduction, new economy, oil shock, PageRank, Ponzi scheme, positional goods, post-industrial society, Post-materialism, post-materialism, principal–agent problem, recommendation engine, Richard Florida, rolodex, Ronald Reagan, Silicon Valley, Skype, statistical model, The Death and Life of Great American Cities, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, women in the workforce, Yom Kippur War

Even the highly publicized layoffs of white-collar employees are a media myth: economists Steven Allen, Robert Clark, and Sylvester Schieber find that average job “tenure and the percentage of employees with 10 or more years of service have actually increased” in large firms, the type that are often spotlighted in news reports.6 In fact, when we look at the economy as a whole, we find that volatility has greatly decreased over the last twenty-five years. Recessions are shallower and recoveries are smoother. Unemployment and interest rates don’t vary as sharply. (Remember 17 percent interest rates on thirty-year mortgages in 1981?) Economists call this “the great moderation” and argue over what has caused it.2† Here’s one of the places where it is important to distinguish between earnings, on the one hand, and income, on the other. Research by none other than the Congressional Budget Office has demonstrated that among those employed, earnings volatility has been flat since at least 1981 (as far back as they were able to look). That doesn’t mean, necessarily, that it is wrong to say that total household income volatility has risen dramatically.


pages: 322 words: 77,341

I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

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asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black-Scholes formula, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, George Akerlof, greed is good, hindsight bias, housing crisis, Hyman Minsky, interest rate swap, invisible hand, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, laissez-faire capitalism, liquidity trap, Long Term Capital Management, loss aversion, Martin Wolf, mortgage debt, mortgage tax deduction, mutually assured destruction, new economy, Nick Leeson, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, tulip mania, value at risk

Alan Greenspan, the head honcho of U.S. monetary policy during the Clinton years, had presided over a period of economic growth during which the U.S. economy seemed to have achieved a highly desirable “Goldilocks point” of being neither too hot nor too cold, so that it kept growing without causing inflation. (Economists sometimes call this period of regular, noninflationary, non-boom-and-bust growth “the Great Moderation.” The term was coined by Greenspan’s successor, Ben Bernanke.) When the dot-com crash came, the fear was that the stock market bust would spread into the rest of the economy and bring it grinding to a halt; so Greenspan responded by cutting interest rates. Non-American readers may wonder what this has to do with them. The answer is twofold. One, the U.S. economy is the biggest in the world, and to a large extent it drives world output and the world economy.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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Airbnb, balance sheet recession, bank run, barriers to entry, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve

As such, even sensible market price corrections were artificially curtailed by the demonstrable notion that, supported by central banks, investors should always buy the dip. And in doing so, they were handsomely rewarded. Repeated and therefore reliable (at least in the eyes of most investors) central bank activism rekindled two of the most powerful terms in the markets’ lexicon: “goldilocks” and the “great moderation.” Their reappearance was fueled by a long period of rock-bottom interest rates—so much so that the highly respected Fed vice chair Stanley Fischer remarked in December 2014 at The Wall Street Journal’s CEO Council, “We have almost got used to thinking that zero is the natural place for the interest rate. It is far from it.” Markets had also gotten used to a prolonged period of unusually low volatility, a gradually improving U.S. economy, and a central bank declaring its willingness to be “patient”—all taken to signal an even longer period of relative economic and financial calm, regardless of how it is artificially sustained.

Unhappy Union by The Economist, La Guardia, Anton, Peet, John

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bank run, banking crisis, Berlin Wall, Bretton Woods, capital controls, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, debt deflation, Doha Development Round, eurozone crisis, Fall of the Berlin Wall, Flash crash, illegal immigration, labour market flexibility, labour mobility, market fundamentalism, moral hazard, Northern Rock, oil shock, open economy, pension reform, price stability, quantitative easing, special drawing rights, supply-chain management, The Great Moderation, too big to fail, transaction costs, éminence grise

Current-account deficits must by definition be financed by capital inflows. Yet there was a widespread belief, echoed on occasion by the Commission and the ECB, that, in a single-currency zone with an integrated financial market, current-account imbalances did not matter any more than they did within federal countries like the United States. In the early 2000s, years that became known as the “great moderation”, when money was cheap, euro-zone countries were able to build up large external imbalances (15% of GDP in Greece). Had they still had national currencies, this would surely have provoked a response from markets. Instead, everybody benefited from low interest rates. Thus was born the great paradox of economic and monetary union. In order for countries to survive within it, they needed to make deeper structural reforms to improve their competitiveness; and yet the pressure to push through those reforms was reduced by the benign mood of financial markets.


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

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Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, moral hazard, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, technology bubble, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs

By computerizing Steinhardt’s art, statistical arbitrageurs such as Jim Simons and David Shaw were taking his mission to the next level. The more markets could be rendered efficient, the more capital would flow to its most productive uses. The less prices got out of line, the less risk there would presumably be of financial bubbles—and so of sharp, destabilizing corrections. By flattening out the kinks in market behavior, hedge funds were contributing to what economists called the “Great Moderation.” But hedge funds also raised an unsettling question. If markets were prone to wild bubbles and crashes, might not the wildest players render the turbulence still crazier? In 1994, the Federal Reserve announced a tiny one-quarter-of-a-percentage-point rise in short-term interest rates, and the bond market went into a mad spin; leveraged hedge funds had been wrong-footed by the move, and they began dumping positions furiously.

Hedge funds built their strategies on short selling, but governments imposed clumsy restrictions on shorting amid the post-Lehman panic. Hedge funds were reliant upon the patience of their investors, who could yank their money out on short notice. But patience ended abruptly when markets went into a tailspin. Investors demanded their capital back, and some funds withheld it by imposing “gates.” Surely now it was obvious that the risks posed by hedge funds outweighed the benefits? Far from bringing about the Great Moderation, they had helped to trigger the Great Cataclysm. This conclusion, though tempting, is almost certainly mistaken. The cataclysm has indeed shown that the financial system is broken, but it has not actually shown that hedge funds are the problem. It has demonstrated, to begin with, that central banks may have to steer economies in a new way: Rather than targeting consumer-price inflation and turning a blind eye to asset-price inflation, they must try to let the air out of bubbles—a lesson first suggested, incidentally, by the hedge-fund blowup of 1994.


pages: 651 words: 180,162

Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb

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Air France Flight 447, Andrei Shleifer, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, credit crunch, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discrete time, double entry bookkeeping, Emanuel Derman, epigenetics, financial independence, Flash crash, Gary Taubes, Gini coefficient, Henri Poincaré, high net worth, Ignaz Semmelweis: hand washing, informal economy, invention of the wheel, invisible hand, Isaac Newton, James Hargreaves, Jane Jacobs, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, Lao Tzu, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, meta analysis, meta-analysis, microbiome, moral hazard, mouse model, Norbert Wiener, pattern recognition, placebo effect, Ponzi scheme, principal–agent problem, purchasing power parity, quantitative trading / quantitative finance, Ralph Nader, random walk, Ray Kurzweil, rent control, Republic of Letters, Ronald Reagan, Rory Sutherland, Silicon Valley, six sigma, spinning jenny, statistical model, Steve Jobs, Steven Pinker, Stewart Brand, stochastic process, stochastic volatility, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, transaction costs, urban planning, Yogi Berra, Zipf's Law

When randomness concentrates, we get the second type, the sneaky Extremistan. 5 Note that people invoke an expression, “Balkanization,” about the mess created by fragmented states, as if fragmentation was a bad thing, and as if there was an alternative in the Balkans—but nobody uses “Helvetization” to describe its successes. 6 A more rigorous reading of the data—with appropriate adjustment for the unseen—shows that a war that would decimate the planet would be completely consistent with the statistics, and would not even be an “outlier.” As we will see, Ben Bernanke was similarly fooled with his Great Moderation, a turkey problem; one can be confused by the properties of any process with compressed volatility from the top. Some people, like Steven Pinker, misread the nature of the statistical process and hold such a thesis, similar to the “great moderation” in finance. CHAPTER 6 Tell Them I Love (Some) Randomness Maxwell in Extremistan—Complicated mechanisms to feed a donkey—Virgil said to do it, and do it now The point of the previous chapter was that the risk properties of the first brother (the fragile bank employee) are vastly different from those of the second one (the comparatively antifragile artisan taxi driver).

Bruno Leoni: I thank Alberto Mingardi for making me aware of the idea of legal robustness—and for the privilege of being invited to give the Leoni lecture in Milan in 2009. Leoni (1957, 1991). Great Moderation: A turkey problem. Before the turmoil that started in 2008, a gentleman called Benjamin Bernanke, then a Princeton professor, later to be chairman of the Federal Reserve Bank of the United States and the most powerful person in the world of economics and finance, dubbed the period we witnessed the “great moderation”—putting me in a very difficult position to argue for increase of fragility. This is like pronouncing that someone who has just spent a decade in a sterilized room is in “great health”—when he is the most vulnerable. Note that the turkey problem is an evolution of Russell’s chicken (The Black Swan). Rousseau: In Contrat Social. See also Joseph de Maistre, Oeuvres, Éditions Robert Laffont.


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

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Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Nate Silver, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

To return to my favorite analogy, we wanted better fire prevention, fireproofing, and fire inspections, along with better-equipped firefighters for the inevitable times when our precautions wouldn’t be enough. The fundamental causes of this crisis were familiar and straightforward. It began with a mania—the widespread belief that devastating financial crises were a thing of the past, that future recessions would be mild, that gravity-defying home prices would never crash to earth. This was the optimism of the Great Moderation, the delusion of indefinite stability. This mania of overconfidence fueled an explosion of credit in the economy and leverage in the financial system. And much of that leverage was financed by uninsured short-term liabilities that could run at any time. This combination of a long rise in borrowing fueled by leverage in runnable form is the foundation of all financial crises, and it would have been dangerous in any financial system.

There’s no way to be sure exactly when a bubble will pop, no certain way to prevent a mania from becoming a panic. Manias are inherently unpredictable, and regulators are not immune to them. Long periods of success in avoiding financial collapses can actually increase vulnerability to catastrophe, because stability can breed instability. At the New York Fed, I got to see how much power the belief in the “Great Moderation” had over smart people, and to witness its expression in the credit boom. Even though we leaned against the prevailing winds, warning about the growth of leverage and the risks of the shadow banking system, taking some useful steps to encourage stress-testing and limit the danger of derivatives, we were not forceful or creative enough, and we didn’t have the tools necessary to avert disaster.


pages: 291 words: 87,296

Lethal Passage by Erik Larson

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Menlo Park, pez dispenser, Potemkin village, Ronald Reagan, The Great Moderation

Yet by tracing the migration of guns, one comes readily and vividly to understand where the nation’s current patchwork of gun controls have gone astray, and how easily they could be fixed to the increased satisfaction of gun owners and gun opponents alike. I chose a single gun, used in a single homicide—not even a terribly lurid homicide—primarily as a means of cutting through the rhetoric of extremists on both sides of the gun debate. Guns are a subject that too often divides America into warring camps, even though the beliefs of the great, moderate mass of Americans, whom we too readily classify in combat taxonomy as pro-gun and antigun, gun nut and gun hater, simply aren’t that deeply opposed. Somewhere along the line, extremists on both sides succeeded in shaping the debate so that no one has a choice but to leap into a trench and start firing away with whatever ammunition has been piled near at hand, be it distorted statistics or empty slogans.


pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

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accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, Bretton Woods, business climate, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, locking in a profit, Long Term Capital Management, McMansion, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

Most policy makers and bankers had never seen such eerily calm markets in their careers, and they were uncertain and divided about what—if anything—they should do. At one end of the intellectual spectrum stood senior American officials, who mostly assumed that the pattern was benign. In January 2006, Ben Bernanke, an esteemed academic economist, took over at the Fed from Greenspan. Earlier in the decade, Bernanke had coined the phrase “the Great Moderation” to describe the new twenty-first-century atmosphere of calm. Both he and Greenspan seemed to think that this “moderation” had arisen because central bankers had successfully crushed inflation and because there was a savings surplus in Asia. Essentially, the argument was that Asian countries were using their foreign exchange reserves to buy US Treasuries and keep rates low. Greenspan and Bernanke were also both keenly aware, though, that credit prices could not keep rising indefinitely.


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

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bank run, banking crisis, banks create money, Basel III, Bretton Woods, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

Brookings Papers on Economic Activity, 2, (pp. 1-73). Alessandri, P., & Haldane, A. (2009). Banking on the State. Bank of England. Arestis, P., & Sawyer, M. (2003). Can Monetary Policy Affect the Real Economy. The Levy Institute Public Policy Brief, 71. Baffes, J., & Haniotis, T. (2010). Placing the 2006/08 Commodity Price Boom into Perspective. The World Bank Development Prospects Group. Baker, G. (2007, January). Welcome to ‘The Great Moderation’. The Times. Retrieved from: http://www.timesonline.co.uk/tol/comment/columnists/article1294376.ece on 27.7.2011. Bank of England. (1999). The Transmission Mechanism of Monetary Policy. Bank of England. Bank of England. (2009). Payment Systems Oversight Report 2008. Bank of England. Bank of England. (2012). The Bank of England’s Real-Time Gross Settlement Infrastructure. Bank of England Quarterly Bulletin, 2012 Q3.


pages: 344 words: 93,858

The Post-American World: Release 2.0 by Fareed Zakaria

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affirmative action, agricultural Revolution, airport security, anti-communist, Asian financial crisis, battle of ideas, Berlin Wall, Bretton Woods, BRICs, British Empire, call centre, capital controls, central bank independence, centre right, collapse of Lehman Brothers, conceptual framework, Credit Default Swap, currency manipulation / currency intervention, delayed gratification, Deng Xiaoping, double entry bookkeeping, failed state, Fall of the Berlin Wall, financial innovation, global reserve currency, global supply chain, illegal immigration, interest rate derivative, knowledge economy, Mahatma Gandhi, Martin Wolf, mutually assured destruction, new economy, oil shock, open economy, out of africa, postindustrial economy, purchasing power parity, race to the bottom, reserve currency, Ronald Reagan, Silicon Valley, Silicon Valley startup, South China Sea, Steven Pinker, The Great Moderation, Thomas L Friedman, Thomas Malthus, trade route, Washington Consensus, working-age population, young professional

The businessmen and financiers who cautiously prepared for political disruptions—unstable governments, terrorism—let their guard down when it came to economic risk. They assumed that the growth of complex financial products (remember the infamy of credit-default swaps, which brought down AIG?) actually reduced risk by spreading it around. They believed that levels of debt that were once considered dangerous were now manageable, given what they assumed were permanently changed conditions owing to the Great Moderation. As a result, investors piled into what would normally be considered dangerous investments, all for the promise of relatively little reward. Credit spreads—the difference in yield between a U.S. treasury bond, considered the world’s safest investment, and the bonds of companies with limited track records—hit historic lows. In 2006 and 2007, volatile countries like Ecuador and teetering companies like Chrysler could borrow almost as cheaply as the U.S. government.


pages: 488 words: 144,145

Inflated: How Money and Debt Built the American Dream by R. Christopher Whalen

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Albert Einstein, bank run, banking crisis, Black Swan, Bretton Woods, British Empire, California gold rush, Carmen Reinhart, central bank independence, conceptual framework, corporate governance, cuban missile crisis, currency peg, debt deflation, falling living standards, fiat currency, financial deregulation, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global reserve currency, housing crisis, interchangeable parts, invention of radio, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mutually assured destruction, non-tariff barriers, oil shock, payday loans, Plutocrats, plutocrats, price stability, pushing on a string, quantitative easing, rent-seeking, reserve currency, Ronald Reagan, special drawing rights, The Chicago School, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, Upton Sinclair, women in the workforce

So the coming financial instability and economic crises, with the twin risks of deflation followed by inflation will be driven not only by the unwillingness to rein in—via proper regulation and supervision—a financial system run amok. They will also be driven by the deeper economic and social forces that have led to income and wealth inequality and a massive rise in private and public debts given the stresses of rising inequality and globalization of trade and finance. So we can unfortunately say goodbye to the Great Moderation and hello to the era of financial instability/crises and economic insecurity. Chris provides us with a fascinating and deep financial history and road map of how we have gone through repeated cycles of great moderations followed by asset and credit bubbles leading to financial crises driven by excessive debt and leverage in the private sector (households, banks, corporate firms) leading to excessive public sector debt accumulation—via socialization of private losses—that leads to twin risks of outright default (usually by U.S. states) or use of the inflation tax through monetization of fiscal deficits (at the federal level).


pages: 374 words: 114,600

The Quants by Scott Patterson

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Albert Einstein, asset allocation, automated trading system, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, NetJets, new economy, offshore financial centre, Paul Lévy, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

The housing market was booming. Economists were full of talk of a Goldilocks economy—not too hot, not too cold—in which steady growth would continue as far as the eye could see. A brilliant Princeton economist, Ben Bernanke, had just taken over the helm of the Federal Reserve from Alan Greenspan. In February 2004, Bernanke had given a speech in Washington, D.C., that captured the buoyant mood of the times. Called “The Great Moderation,” the speech told of a bold new economic era in which volatility—the jarring jolts and spasms that wreaked havoc on people’s lives and their pocketbooks—was permanently eradicated. One of the primary forces behind this economic Shangri-la, he said, was an “increased depth and sophistication of financial markets.” In other words, quants, such as Griffin, Asness, Muller, Weinstein, Simons, and the rest of the math wizards who had taken over Wall Street, had helped tame the market’s volatility.


pages: 790 words: 150,875

Civilization: The West and the Rest by Niall Ferguson

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Admiral Zheng, agricultural Revolution, Albert Einstein, Andrei Shleifer, Atahualpa, Ayatollah Khomeini, Berlin Wall, BRICs, British Empire, clean water, collective bargaining, colonial rule, conceptual framework, Copley Medal, corporate governance, credit crunch, David Ricardo: comparative advantage, Dean Kamen, delayed gratification, Deng Xiaoping, discovery of the americas, Dissolution of the Soviet Union, European colonialism, Fall of the Berlin Wall, Francisco Pizarro, full employment, Hans Lippershey, haute couture, Hernando de Soto, income inequality, invention of movable type, invisible hand, Isaac Newton, James Hargreaves, James Watt: steam engine, John Harrison: Longitude, joint-stock company, Joseph Schumpeter, land reform, land tenure, Louis Pasteur, Mahatma Gandhi, market bubble, Martin Wolf, means of production, megacity, Mikhail Gorbachev, new economy, probability theory / Blaise Pascal / Pierre de Fermat, profit maximization, purchasing power parity, quantitative easing, rent-seeking, reserve currency, road to serfdom, Ronald Reagan, savings glut, Scramble for Africa, Silicon Valley, South China Sea, sovereign wealth fund, special economic zone, spice trade, spinning jenny, Steve Jobs, Steven Pinker, The Great Moderation, the market place, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, Thorstein Veblen, total factor productivity, trade route, transaction costs, transatlantic slave trade, transatlantic slave trade, upwardly mobile, uranium enrichment, wage slave, Washington Consensus, women in the workforce, World Values Survey

Nemesis came first in the backstreets of Sadr City and the fields of Helmand, which exposed not only the limits of American military might but also, more importantly, the naivety of neo-conservative visions of a democratic wave in the Greater Middle East. It struck a second time with the escalation of the subprime mortgage crisis of 2007 into the credit crunch of 2008 and finally the ‘great recession’ of 2009. After the bankruptcy of Lehman Brothers, the sham verities of the ‘Washington Consensus’ and the ‘Great Moderation’ – the central bankers’ equivalent of the ‘End of History’ – were consigned to oblivion. A second Great Depression for a time seemed terrifyingly possible. What had gone wrong? In a series of articles and lectures beginning in mid-2006 and culminating in the publication of The Ascent of Money in November 2008 – when the financial crisis was at its worst – I argued that all the major components of the international financial system had been disastrously weakened by excessive short-term indebtedness on the balance sheets of banks, grossly mispriced and literally overrated mortgage-backed securities and other structured financial products, excessively lax monetary policy on the part of the Federal Reserve, a politically engineered housing bubble and, finally, the unrestrained selling of bogus insurance policies (known as derivatives), offering fake protection against unknowable uncertainties, as opposed to quantifiable risks.


pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

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Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, Bretton Woods, BRICs, business climate, capital asset pricing model, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, moral hazard, mortgage tax deduction, naked short selling, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

It is possible that somehow the simple injection of massive amounts of fresh credit might forestall the crisis unleashed in 2008 from leading to a call for hard money. But if leverage remains high, almost certainly a series of crises such as was the case in Rome might ultimately bring the pendulum back toward gold. Chapter 19 America Invicta ederal Reserve officials refer to the period of economic recovery that followed the collapse of the Internet bubble as “The Great Moderation,” because inflation, interest rates, and the volatility of financial markets were low. The credit meltdown was unexpected, and it has spawned conflicting prognostications ranging from deflation to hyperinflation. Unprecedented fiscal and monetary policy stimulation has been undertaken, but the possibility of hindering growth through higher taxation looms. For the first time in nearly a century, the possibility of a gold standard is imaginable, although remote in the eyes of the mainstream financial commentators.

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

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Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Nick Leeson, P = NP, pattern recognition, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

My fellow students saw the United States as a fascist state likely to turn JWPR007-Lindsey May 7, 2007 17:27 Allan Malz 297 their continent into a sheet of radioactive glass. I respected their views, since they seemed to be more conversant with American popular culture than me. How Not to Get a PhD, Continued After harvesting a degree from Munich University, the time came to return to the States and see if I could earn a living. Although it had nothing to do with my personal choices, The Great Moderation had begun, and the prospects for finding work were far better than during the leaden 1970s. Back in New York, my first job was as an economist at the Federal Reserve Bank of New York, in a department quaintly named the Industrial Economies Division, in contrast to the Developing Economies Division. Today, I suppose, I would be working in the Service Economies Division and the emerging markets area would be Industrial Economies Division.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, new economy, oil shock, passive investing, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

Recessions have become shorter and milder and expansions longer. The last economic expansion in the United States lasted a record 10 years from March 1991 to March 2001. Economic expansions in Europe have lasted even longer: the last recession in the United Kingdom ended in 1995 and much of the Eurozone has been recession free for more than a decade. Economists call this trend toward greater macroeconomic stability “The Great Moderation.”18 The moderation has been attributed to better monetary policy; a larger service sector, which is inherently more stable than the goods sectors; and better inventory and production control, enabled in part by the information revolution. Whatever the reasons, greater macroeconomic stability should lead to greater stability of earnings and a lower equity premium. The lower 16 Chelcie C.


pages: 494 words: 132,975

Keynes Hayek: The Clash That Defined Modern Economics by Nicholas Wapshott

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airport security, banking crisis, Bretton Woods, British Empire, collective bargaining, complexity theory, cuban missile crisis, Francis Fukuyama: the end of history, full employment, Gordon Gekko, greed is good, if you build it, they will come, Isaac Newton, Joseph Schumpeter, liquidationism / Banker’s doctrine / the Treasury view, means of production, Mont Pelerin Society, mortgage debt, New Journalism, Northern Rock, price mechanism, pushing on a string, road to serfdom, Ronald Reagan, Simon Kuznets, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Malthus, trickle-down economics, War on Poverty, Yom Kippur War

Friedman, not Keynes, was credited with solving the mystery of why the Great Depression of the 1930s occurred and how it could be prevented from happening again. In a ninetieth birthday tribute to Friedman, Ben Bernanke,15 the Federal Reserve chairman at the time, offered a belated apology for the Fed’s shortcomings in the 1920s. “Regarding the Great Depression,” he declared, “you’re right. We did it. We’re very sorry. But, thanks to you, we won’t do it again.”16 The individual who bound together the whole of this period, dubbed the “Great Moderation,” and who came to personify the bipartisan approach of a largely Friedmanite monetary policy within a generally managed economy, was Alan Greenspan. His stewardship of the Federal Reserve from 1987 to 2006 was hailed as masterly. If he made false steps, they did not become apparent until long after he had departed. In his youth Greenspan learned the saxophone alongside Stan Getz, played sideman in a jazz band with the pop artist Larry Rivers, and flirted with both the termagant Ayn Rand and her libertarian ideas.


pages: 823 words: 206,070

The Making of Global Capitalism by Leo Panitch, Sam Gindin

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accounting loophole / creative accounting, airline deregulation, anti-communist, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Basel III, Big bang: deregulation of the City of London, bilateral investment treaty, Branko Milanovic, Bretton Woods, BRICs, British Empire, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collective bargaining, continuous integration, corporate governance, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, dark matter, Deng Xiaoping, disintermediation, ending welfare as we know it, eurozone crisis, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, full employment, Gini coefficient, global value chain, guest worker program, Hyman Minsky, imperial preference, income inequality, inflation targeting, interchangeable parts, interest rate swap, Kenneth Rogoff, land reform, late capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, Northern Rock, oil shock, precariat, price stability, quantitative easing, Ralph Nader, RAND corporation, regulatory arbitrage, reserve currency, risk tolerance, Ronald Reagan, seigniorage, shareholder value, short selling, Silicon Valley, sovereign wealth fund, special drawing rights, special economic zone, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, very high income, Washington Consensus, Works Progress Administration, zero-coupon bond

Yet the Clinton administration was then the beneficiary of an upsurge in US productivity through the 1990s that had its roots in the class realignment and industrial restructuring of the previous decade. After the brief recession of the early 1990s, this led to an economic expansion of unprecedented length, during which unemployment dropped to almost 4 percent, its lowest in thirty years. By the beginning of the new millennium, mainstream economists had begun to refer to the whole period after the mid 1980s as the “Great Moderation,” while pundits in the New York Times asked “what word but ‘empire’ describes the awesome thing that America is becoming?”95 But if the angst-ridden 1980s thesis of “American decline” by then looked quite overblown, it was equally misleading to describe the subsequent period in the self-satisfied terms of economic stability. The defining characteristic of the period was neither decline nor moderation, but restructuring.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

The 1980s inflation was lower, but still high at 5.06% per year. There was very high inflation early on in the 1980s until Volker and Reagan attacked it full on and brought it down from double-digit levels to low single-digit levels. From 1990 to 2008, inflation remained quite low. One of the reasons that inflation remained so low is that the Federal Reserve specifically focused on a low target inflation rate. Some people have called this period the great moderation, which refers to the stable inflation, stable economy that has been experienced since the mid-1980s, prior to the financial crisis. Then came the financial crisis. Since the financial crisis began annual inflation has been relatively low at 1.97%. This average contains a period of deflation. A better sense of inflation during and after the financial crisis is contained in Figure K.6. The worry is that with the Fed lowering interest rates to zero and all of their unusual policy actions, the economy will have to face massive inflation in the future.