Alternative Perspectives on the Global Financial Crisis
Edited by Steven Kates
Chapter 13: Excess Debt and Asset Deflation
Jan Toporowski INTRODUCTION: THE FAILURE OF ECONOMIC THEORY The financial crisis that is spreading out from countries with the most ‘advanced’ financial systems to the rest of the world has not been well served by economic theory. That is to say, economic theories did not, as they should, prepare policy-makers and practitioners for the crisis, and few theorists have been able to illuminate the course of the crisis and its implications with anything other than the insights that had conspicuously failed to prepare us for such a crisis. In the mainstream, new classical economics has modelled a very attenuated financial system, driven by ‘rational’ individuals exchanging real resources to obtain such allocations in general equilibrium that maximize utility functions now and over time. Disturbances arise because of unanticipated ‘shocks’, following which general equilibrium is resumed. This unworldly philosophy ignores the very apparent macroeconomic imbalances that built up over many years (and therefore can hardly be described as ‘unanticipated shocks’) and that are now working themselves out in the deflation of economies. However, that philosophy still plays a very real part in the thinking of policy-makers. Their general equilibrium models still reassure us that what is clearly emerging as a lengthy deflationary process is a temporary response to the shock of bank defaults, and that stable growth will be shortly resumed (Bank of England, 2008). The new Keynesians have also been intellectually hamstrung by a methodological addiction to general equilibrium. This was used to model underemployment equilibria due to market ‘rigidities’....
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