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A brief description of the crisis

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

This chapter briefly describes the key characteristics of the contemporary crisis. The first characteristic is related to the place where it originated. The second concerns the phenomenon that triggered the crisis, that is, the substantial increase in delinquencies in a specific category of residential mortgages, namely, the so-called subprime mortgages. The third characteristic had to do with the evolution of the crisis since 2007.

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Mainstream economists and the crisis

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

Mainstream economists see the contemporary crisis as a phenomenon due to the errors made by the Federal Reserve and the US banking system. This chapter analyses three separate explanations for the origins of the crisis that differ depending on the culprit.

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The limits of the mainstream theory

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

This chapter shows that there is a sharp contrast between the explanations described in the previous and the dominant theory of money and finance. The mainstream theory describes an economic system in which no crisis can ever occur, that is, a system in which: 1) monetary authorities control the amount of money but not the supply of credit which depends on saving decisions; 2) banks are mere intermediaries that do not create risks; 3) the process of wealth accumulation and the phenomenon of speculation are not relevant. However, when explaining the origins of the crisis, mainstream economists refer to a profoundly different system. In fact, they recognize that the crisis developed in a context in which: 1) the supply of credit depends on the choices made by the banking system and not on the agents’ savings decisions; 2) the financial system can create risk; and 3) the phenomenon of speculation is relevant. The conclusion drawn in the first part of the book is that the current crisis should lead the economics profession to develop an alternative theoretical approach capable of explaining the functioning of an economic system that features these three characteristics.

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Keynes and the monetary theory of production

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

This chapter shows that in order to elaborate an alternative theoretical approach it is necessary to rediscover the lesson of a large group of heretical economists including Marx, Keynes, Schumpeter, Kalecki, Kaldor and Minsky. In particular, the chapter highlights Keynes’s and Schumpeter’s analysis. The contributions made by these two great economists led to the conclusion that money is an essential element for the explanation of the two fundamental characteristics of contemporary economies: 1) the process of economic development driven by innovations; and 2) economic crises.

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Finance and risk

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

To explain the relationship between monetary policy and credit supply, this chapter underlines that both Keynes and Schumpeter based their analysis on bank money, namely, money created through a credit agreement. The relationship between finance and risk, which is crucial in one of the mainstream interpretations of the crisis, was described by referring to the concepts of Keynesian uncertainty and Schumpeterian innovation. Keynes’s and Schumpeter’s analyses highlight the monetary nature of uncertainty, as they allow the definition of a causal relationship between the presence of bank money and the innovations implemented by entrepreneurs. This causal sequence explains the relationship between finance and risk that characterizes the mainstream explanation of the crisis.

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Saving decisions, wealth and speculation

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

The mainstream interpretations of the crisis also rely on concepts such as speculation and speculative bubble that are completely alien to the traditional theory. This chapter shows that the phenomenon of speculation can be explained by specifying the relationship between savings decisions and the stock of wealth emphasized by Keynes when he describes a monetary economy. The importance of the wealth accumulation process emerges in the context of an economy in which needs are insatiable because innovations continuously determine the production of new goods and the appearance of new needs.

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Money and crisis

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

This chapter shows that Keynes’s monetary economy and Schumpeter’s capitalist economy are not stable structures converging towards a full employment equilibrium but systems that are characterized by an evolutionary process marked by phases in which capitalism takes different forms. The crisis thus represents an expression of the fragility of a specific form of capitalism and a sign of transition from one form of capitalism to another. The monetary theory of production presented in this chapter is based on two points. First, it underlines the monetary nature of the Keynesian principle of effective demand. Second, it shows, following Kalecki and Minsky, that there are no measures that can truly drive a monetary economy towards a permanent state of full employment.

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The endogenous nature of the subprime crisis

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

This chapter shows that the thesis whereby the current crisis is an accidental phenomenon, caused by the mistakes made by US government, Federal Reserve and the US banking system, has no meaning. It describes the endogenous nature of subprime mortgage crisis. The chapter also points out that, while economic crises are endogenous phenomena, they are not inevitable. In fact, they cannot be compared to natural events such as earthquakes because they are a consequence of the economic decisions taken by the various stakeholders of a society. This difference has major consequences. In fact, earthquakes are not only unpredictable but also inevitable. This means that the probability of their occurrence is completely independent from the theories developed by seismologists to explain their origin. This is not true for economic crises; the likelihood of their occurrence is not at all independent from the way that economists theorize the functioning of a market economy. The elaboration of a theory whereby a catastrophic crisis cannot occur has increased the outbreak of the Great Recession in two ways: 1) it led economists to completely underestimate the signs of instability that emerged during the Great Moderation; 2) it fostered behaviours and choices that paved the way to the crisis.

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Overcoming the crisis: which policies?

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco

The first objective of this chapter is to underline the limits of the mainstream economic policies. In fact, they represent the manifestation of a paradox as they are inspired by the same neoliberal ideology that created the conditions for the outbreak of the crisis. Indeed, it is unlikely that an incorrect diagnosis may produce a successful therapy. The second objective is to define the characteristics of a set of policies that overcome the limits of the Keynesian policies and take into account the structural nature of the contemporary crisis.

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Conclusions

The Responsibility of Economists for the Great Recession

Giancarlo Bertocco