Dynamics of the Global Financial CrisisAppalling guidance by neoclassical economists OECD World Economic Outlook, June 2007, p. 9: “the current economic situation is in many ways better than what we have experienced in years Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.” Jean-Philippe Cotis, Chief Economist Crisis began August 9 2007just 2 months later! BNP closes 3 funds with strong subprime exposure Different theory needed to understand crisis:Minskys “Financial Instability Hypothesis” Explanation for regular credit-driven cycles economic growth slows Economy enters a debt-induced recession Back where we started.Crisis and Aftermath High Inflation? Debts repaid by rising price level Economic growth remains low: Stagflation Renewal of cycle once debt levels reduced Low Inflation? Debts cannot be repaid Bankruptcy affects even non-speculative businesses Economic activity remains suppressed: a Depression Big Government? Anti-cyclical spending enables debts to be repaid Renewal of cycle once debt levels reducedCrisis and Aftermath Modelling Minsky Extension of Goodwins Growth Cycle to include debt 3 “stylised facts” Wages share grows if wage rises exceed productivity Employment rises if growth exceeds productivity + population increase Bank lend money to finance investment Dynamics Borrow money to finance investment during a boom Repay some of it during a slump Debt to income levels ratchets up through series of booms/busts Eventually one boom where debt accumulation passes “point of no return”Modelling Minsky or Widespread debt moratoria Problem too big to “paper over”The problem Debt/GDP twice as bad as prior to Great Depression USA 1929: 150% 2008: 290% Australia 1929: 64% 2008: 165% Common across OECD: Position probably far worse once impact of derivatives, off balance sheet SIVs, etc. includedProspects Government deficit spending justified Cash flow to private sector assists debt repayment But scale of problem will overwhelm financial rescue Spending sum of GDP + Change in Debt Last year GDP $1,080bn; change in debt $259bn Change in debt20% aggregate demand Even debt stabilisation means drastic drop in demand Debt stabilisation $259bn cut to spending Debt reduction to say 75% GDP (triple 60s level) $100bn/year cut in demand for next 10 years? Government spending cant counteract this Witness Japan:Omens Japans “Bubble Economy” crisis a precursor to Subprime Crisis Debt-financed speculative bubble Burst end-1989 Two decades later, still in low level Depression Government debt far higher, private debt slightly lower But economy still mired in economic slumpCant “pump prime” way out of debt crisis this big Simply swaps public debt for private Debt should never have been issued in the first placeSolutions? Only solutions involve drastic cut in Debt/GDP ratio Deliberate Inflation? Debt moratoria? Post-crisis reforms Palliative reforms (Glass-Steagall Act, etc.) will be “reformed” away once they cause prolonged stability Long term success only if possibility of profitable asset price speculation virtually eliminated Alter nature of share ownership Alter property valuation Re-assign risk from borrowers to lenders And think differently about the economy in future Less ideology (left or right!) and more knowledgeAlternative economic theory needed too! Economic theory in part got us into this mess Ignoring role of money & debt Fetish on equilibrium when economy far from it Nave view of role of finance markets “Efficient Market Hypothesis” Insane view of rationality rationality as ability to predict the future! Didnt see this crisis coming Can you trust conventional (neoclassical) theory to Know what comes next? Get us out of it? Alternative theories of economics needed Some exist but are underdeveloped Best is Minskys Financial Instability HypothesisDont get fooled againSome other alternatives Post-Keynesian economics http:/www.levy.org/ http:/cas.umkc.edu/econ/ Evolutionary economics http:/www.themeister.co.uk/economics/evolu tionary_economics.htm http:/www.business.aau.dk/evolution/ Complex systems analysis & “Econophysics” Physicists doing economics http:/www.unifr.ch/econophysics/ For more information & analysis: