Post Keynesian Theory and Policy

Post Keynesian Theory and Policy

A Realistic Analysis of the Market Oriented Capitalist Economy

New Directions in Post-Keynesian Economics series

Paul Davidson

How did economic “experts” worldwide fail to predict the financial crisis of 2007-2008? Eminent economist Paul Davidson discusses how mainstream economic theory may not be applicable to the world of experience. Post Keynesian theory is designed to be applicable to the real world, and this book demonstrates how applying it to policy formulation could help practically resolve economic problems. Davidson goes on to demonstrate how many Post Keynesian economists warned of the impending financial crisis as early as 2002.

Chapter 2: Alternative theories of the operation of a capitalist economy

Paul Davidson

Subjects: economics and finance, history of economic thought, post-keynesian economics


The financial crisis that began in 2007–2008 started as a small default problem on some subprime mortgages that had been issued in the United States. These defaulting subprime mortgages were part of the mix in mortgage backed derivatives. As a result, holders of these derivatives began to fear that the mortgages in their specific derivative financial asset holdings might also soon fall into default. Consequently, many derivative asset holders tried to make fast exits from the markets for such assets as the fear of potential defaults spread. With many holders rushing to exit the market while few or none were willing to buy more of these assets, the market prices of derivatives crashed. The result was to reduce the asset side of balance sheets of institutions that held these derivatives to the point of insolvency. This effect quickly ballooned globally into the largest threat to economic prosperity since the Great Depression. What is rarely noted is that the origin of this latest global financial market crisis, like the New York Stock Exchange crash of 1929 that appears to have precipitated the Great Depression, is associated with the operation of free financial markets unhampered by government regulations. In recent decades, many mainstream academic economists, central bankers, most policy makers in government and their economic advisers have advocated freeing financial markets from government rules and regulators.

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