Second posting CEA paper Post crash macroeconomics:the eclipse of rational expectations monetarism and the need for a new synthesis

Chorney, Harold (Concordia University Montreal

Title Post-crash macroeconomics: The eclipse of rational expectations monetarism and the need for a new synthesis.
Abstract Most of the classical and Neo-classical macroeconomics edifice imploded with the crash of 2007–2009. Instead of market clearing equilibrium extreme instability in financial markets worldwide demonstrated that irrational behaviour in real estate and connected financial derivatives markets had enormous destructive consequences that could only be countered by unconventional monetary policy and significant state intervention. Substantial deficits and quantitative easing were necessary to overcome the downturn. None of this approach was recommended by new classical macroeconomics or rational expectations monetarism. Long-rejected Keynesian and post-Keynesian strategies and policies were implemented instead. After more than nine years of these policies inflation has been largely dormant and central banks have had difficulty in reaching their inflation targets. Quantity theory arguments about inflation appear to no longer be explanatory. What is needed now is a synthesis of traditional Keynesian and post-Keynesian approaches that incorporates these policy reforms and accounts for labour market behaviour in the context of globalization, trade liberalization, financial market instability and targeting low unemployment. This new emerging global model will increasingly be a factor in domestic markets for years to come and poses a grave challenge to policy makers who face the dilemma of achieving low unemployment, rapid yet ecological growth and creative technological innovation which will support prosperity and quality social programs for the population as a whole and younger people in particular.
Primary Area Macroeconomics, Business Cycles
Secondary Area History of Economic Thought
Methodology Primarily Theoretical






The financial crisis and stock market crash of 2007–2009 was a cataclysmic event that brought much of the global financial system to the precipice of catastrophic failure. Like other great crashes before it in previous centuries, the wreckage was widespread and revealed systemic problems with the conventional wisdoms that dominated leading policy, political and academic circles. ( Schumpeter, Kindleberger, Lamontagne,Chorney, Fortin, Stiglitz, Reich) In the first place those economists who knew little of economic history, or if they knew interpreted it within a very narrow theoretical framework, were convinced that this event could not happen. The quants on Wall Street (some of whom I had met and come to know because of an IBM-sponsored event in NYC at the Levin institute  SUNYin which I participated in May 2009 to analyse what had gone wrong and how it could be avoided in the future) were genuinely puzzled at the causes of the collapse, which they had hitherto believed literally so remote an outcome in the scheme of probabilities as to have been virtually impossible. They were, of course, mostly previously unaware of the work of Benoit Mandelbrot on fractal mathematics, Keynes on uncertainty and only recently become aware of Hyman Minsky on the financial instability hypothesis. (Mandelbrot, Keynes, Minsky) The cataclysmic, near total destruction of Wall Street in the great crash of derivatives and the fraud ridden sub-prime housing market in the 2008 slaughter thoroughly frightened the world. I wrote at length about the crash as it occurred and then again in 2011 I analysed it in a major paper posted on my web site and presented to the Eastern Economics association meetings in NYC. This is part of what I wrote at the time. I think it bears repeating because the gravity of what happened was very large and the lessons that were needed to be learned by the policy makers and policy specialists were fundamental and potentially paradigm shifting.


Over the three weeks (October 2–October 25, 2008) the collapse in stock markets became a frightening global phenomenon. On Friday October 24th, the markets dropped world-wide by over 316 points in the US Dow Jones, by 9.6 % in the Nikkei index in Japan and by 4-5 % in Europe and substantially in China as well. The Dow Jones had fallen from its peak of 14,164 a year before October 10th to just over 8300, a fall of over 40 %— one of the larger drops in its history. By March of 2009 it had fallen to a low of 6600. Only the drops in 1919–1921, 1929–1932, 1937–38, 1939–1942, 1973–1974 were greater. The S and P 500 index, in fact, suffered the second biggest slide in its history also falling by more than 42 %. The NASDAQ had fallen by 44.7 % over the year and the Russell 2000 by 42.6 %.


Indices all over the world were down by between 33 and 71 %. These included Canada -32.8 %; Brazil-50.7; Mexico -42.5; Euro zone – 48.3; Switzerland -33.1; U.K. -39.9; Russia –71.1; Australia -39.0; China -65.8; Hong Kong -54.6; Japan -50.0 ; Singapore -53.8; South Korea -50.5; Taiwan -46.2. From October 26 to November 13 the market fluctuated wildly, culminating on November 13 with a swing of 900 points in one day from a new bottom of about 7800 on the DOW to a close of just over 8800.


The very next day however the market opened with a downturn suggesting that volatility and a sense of no clear direction remained the key characteristic as more bad economic news was released with deepening recessions in the U.K., Germany and the U.S. leading the way.

Oil had also fallen from its year earlier cash spot price of $91.87 to a low of about $54 for West Texas Intermediate on the cash spot market. On the futures market it had peaked at $147 but it then fell to $56 on NYMEX. ( Its January 2009 price was as low as $37. By February 2011,  the price of NYMEX oil was once again about 100 $ a barrel as instability in the Middle East accompanying the Arab revolution has led to considerable nervousness in the futures and spot markets. (It is interesting that this was another cartel engineered spike in retail gas prices. Indeed, gas prices have risen from  $ 1.35 to over 1.50 a litre once again literally overnight in Montreal in 2018 as the world cartel driven price heads up to as high as $80 or more a barrel.)


OPEC cut its production quotas during this earlier period but prices still fell. Almost all of the other leading commodities had also fallen in price including copper, aluminum, platinum, lead, steel, tin, zinc coffee, wheat, corn , sugar, cheese , milk, corn oil and soybean oil. Over the next 12 months they recovered substantially.


Over the past 118 years there have been 100 episodes in which the Dow lost 10 % or more over the highest previous close in the previous 30 days. Of these, in 45 cases the Dow was higher three months later. In a number of cases there were longish bear markets that followed and in three cases —1907, 1929 and 1973 — these depressed markets lasted several years. The August 1929 peak was only regained in November 1954. (Niederhoffer, pp.42-43) The 1973 peak in 1979 and the 1907 peak in 1910.

Markets world-wide experienced similar dramatic losses and the paralysis of the banking sector had worsened despite passage of the bailout Bill. To combat this the Treasury then implemented the provisions of the Bill which permitted taking share ownership in return for injecting new capital. In this respect they were influenced by the approach of the British Labour government led by Gordon Brown which announced it was injecting 37 billion pounds into RBS, Lloyds and HBOS in return for equity in order to prevent their collapse. (New York Times , October 8, Guardian October 13, 2008). In return the Banks agreed to help prevent foreclosures and executives agreed to limitations on bonuses and compensation packages. The British government ended up owning 43.5 % of the Lloyds HBOS group and 60 % of the RBS. It also made 6.5 billion pounds available to Barclays should they decide to take it up. Barclays however refused the offer.


George Soros also had suggested a variant of the British plan in an article in the Financial Times (October 12, 2008) which involved injecting both public and private capital into the banks in return for preferred shares. These measures, of course, diluted the current shareholders’ common stock and entailed further losses, but in the longer run  helped rescue the banks from collapse. At the same time European leaders announced that were going to guarantee inter-bank lending in what would  eventually turn out to  be a successful effort to unlock the credit markets. Germany set aside 80 billion euros to recapitalise its banks and France 40 billion euros. In addition, the European central bank, the Bank of England and the Swiss central bank offered their commercial banks unlimited swap loans of varying maturities and large quantities denominated in dollars in exchange for appropriate assets. All of these measures introduced substantial new liquidity into the financial system. If one totals up the European programs the total money involved was close to 2 trillion US dollars.

The US under the TARP injected up to $245 billion into American banks with the largest 8 banks receiving a total of $125 billion. (As of March 2018, the program is estimated to have cost  a far cry from the original outlay and the final gross bill of 443 billion before profits are taken into account. According to the March 2018 TARP report the net cost of Tarp will be 32 billiondollars.


By CBO’s estimate, $444 billion of the $700 billion initially authorized will be disbursed through the TARP, consisting of $439 billion already disbursed and $4 billion in projected future disbursements. CBO estimates that the government’s total net subsidy costs—including those already realized and those stemming from outstanding and anticipated transactions—will be $32 billion. The estimated cost of the TARP stems largely from assistance to American International Group (AIG Insurance), aid to the automotive industry, and ongoing grant programs aimed at preventing foreclosures on home mortgages. Taken together, other transactions with financial institutions have yielded a net gain to the federal government from interest, dividends, and capital gains





The banks received the initial capital and the Government took preferred shares in exchange and guaranteed senior debt for 3 years. The FDIC insured all non-interest bearing accounts which were primarily used by business. The biggest American banks received the money as follows: Bank of America $25 billion; Citigroup 25 billion; JP Morgan Chase 25 billion; Wells Fargo 25 billion; Goldman Sachs 10 billion; Morgan Stanley 10 billion; Bank of New York 2–3 billion; and State Street 2–3 billion. Most of these banks have now returned the money with interest and the government has sold the shares they acquired for a profit. The total TARP program which also aided the auto companies and AIG insurance in addition to the banks paid out a total of 443 billion plus and, so far, has returned most of the money with a final net cost estimated to be 32 billion.


It is possibly true that a different approach would have yielded far greater profits to the taxpayer, increased the flow of funds through the economy, permitted greater future reform, and prevented some of the excessive bonuses that were paid out as Stiglitz and other critics have argued. Nevertheless, the fact is that TARP cost a fraction of what it originally was expected to and on the whole it worked to save the financial system and therefore the American economy from complete collapse, albeit imperfectly. Had it collapsed, the depth and duration of the recession-depression would have been far greater and the damage to the labour force even greater.


The American and British action in fact represented a partial temporary nationalization of banks and the goal was to unlock the credit markets and restore the proper functioning of the banking system. None of the governments was willing to say that their actions constituted de factonationalization but in fact that is what they were doing, albeit temporarily in an emergency. The British Government stated it had no intention of hanging on to the Banks for long, but a decade later the government still owned a major chunk of RBS. It initially took over Northern Rock,Lloyds and the Royal Bank of Scotland and pumped £500 billion through its rescue packages into the banking sector. The net cost to the taxpayer hit 27b £ after the eventual resale of shares, Brexit increased the net cost because the value of the bank shares fell after the yes side won as bank stocks in Britain fell in value.(Independent, Nov.24, 2016) As of fall 2016 the British government still owned 25% of Lloyds shares and in total had pumped in over £ 20 billion into the bank. These actions also reveal just how serious the crisis had become.


The American action was also time limited with the clear intention of returning the banks to private ownership as soon as conditions had stabilized and the Government could recover its investments. As of the beginning of 2018 the British government still owned 70.33% of the share equity in RBS after selling some of the shares to the public for a profit. The British government took over Northern Rock bank and eventually split its riskier mortgage assets apart from its other banking assets and sold them to Virgin Money plc for 747 million pounds plus future potential considerations worth over 225 million pounds in 2012. The rest of the bank‘s assets were not sold but placed in a separate firm.Northern Rock‘s problems in the mortgage area broke out in September 2007 with a run by depositers on the bank when it was revealed it was being bailed out by the Bank of England.. This was the first run on a retail British bank in the U.K. since the nineteenth century.


The problem in 2007,2008 and 2009 and to some extent 2010 appeared to still be, despite these massive infusions of cash, that no one trusted anyone else as to their counter party risk exposure. As a consequence, the banks appeared to be using the infusions not to unblock the credit and loan system but rather hoarding the cash, to improve their balance sheets and possibly for takeover acquisitions, while tightening credit to reflect the then current head-for-the-hills market sentiment. They also angered the public, understandably, when they appeared to use the money to pay out huge bonuses to their senior management. This required further intervention by the American Government and governments in other countries facing similar problems to insist that the banks use the money for the purposes intended.


In effect, we had the outcome that Keynes foresaw in The Treatise on Money in his chapter on fluctuations in the rate of investment and his earlier discussion of the role of liquid capital (pp.116 ff vol2 &pp.59ff) in which he argued that disproportionalities in the savings and investment functions would lead to co-ordination problems in the economy and that excessive liquidity preference by the banks themselves could lead to inadequate investment and too high a rate of interest prevailing in inter-bank lending during a slump. (Keynes, Treatise, p.182 vol.2; See also the discussion of this in Minsky, KeynesStabilizing;A.Leijonhufvud, On Keynesian Economics😉 This was precisely the situation we had faced over the years 2007–2010 and the great challenge was to get the banks to lend again at reasonable rates of interest.


As of November 13 2008, the Treasury Secretary Henry Paulson announced that he was abandoning his plan to acquire toxic assets from the banks and instead was shifting his focus to use TARP funds to inject capital into the asset-backed commercial paper markets that are linked to car loans, student loans and credit card debt. The government also announced on November 9 that it was increasing its injection of funds into AIG insurance by some $40 billion in order to reduce the burden of interest on previous loans to the company. The government injected some $152 billion into AIG through a combination of low-interest loans, purchase of preferred shares and the establishment of a funded entity to offload and resell bad debt.

Great Britain has already ordered that its banks use the funds advanced to them to unlock their credit markets. Paulson’s decision to refocus his attention on the non-bank consumer-oriented financial markets was a way of putting pressure on the banks to do so. By having refused to do so despite the advances made to them the banks will now have to accept lower prices for their toxic debt than what they would have been able to wring from the Treasury.




Those of the Wall street quants who I met at the Levin institute conference who were trained in economics and finance, a good number of them believed that rational expectations theory guaranteed totally rational behavior based on the best economic model being believed and followed by the economic actors involved. As Robert Barro describes it, rational expectations says that people‘s beliefs correspond to optimal predictions given the best available information. (See also Fortin) Then we use statistical techniques to figure out these optimal predictions. Barro adds use market data such as interest rates or prices of financial contracts to infer what people believe. Lucas in his work on business cycles and rational expectations argues in the preface that his research in the 1970s forced himself away from Keynesian theory as he understood it— he famously confesses in another interview that he finds the GT ‘‘unlikeable not a very congenial book to read‘‘ …carelessly written, not especially gracefully written, sometimes dishonestly written‘‘ p.50 in Klamer. His bad reaction to Keynes was reinforced during the 1970s as he found himself moving toward  the view taken by many pre-Keynesian general equilibrium theorists‘‘ During the period that followed the 07–09 crash Lucas did not seem to appear much in the media despite his Nobel prize status to explain what had gone wrong and how rational expectations about optimal policy had not carried the day. (Rapley, How the Great Recession destroyed  our faith in Economists, Brave New, see also Richard Posner , Economists on the Defensive—Robert LucasThe Atlantic Aug 9, 2009) He did admit that his view of cycles had changed somewhat and that there were clear differences between smaller cycle disturbances and large ones involving financial panic.


The purist general equilibrium theorists had argued that there could not be a financial and real estate bubble because that would entail irrational behavior based on an inferior non-optimal economic model that had been surpassed by modern economic theory. Alan Greenspan, who left his position at the Fed only months earlier, to his credit admitted he had believed likewise and he had been wrong to have done so.


What relevance is a NYC meeting of this nature held at the Levin institute in NYC not long after the crash? Well, first of all, Wall St and NYC is one of the financial capitals of the world, or at least of North American capitalism. Except for myself and several Fed reserve analysts, the remaining participants at the conference were all financially affluent Wall Street insiders. I regarded them with a certain degree of respect both for their personal net worth and also for their genuine concern at what had happened, but I was somewhat shocked that when I asked them about what had happened, why their fail-safe models had failed, they had no answer except to say they were not sure as to what had led to the collapse in the derivative products they had sold and managed. Furthermore, they were not sure how a repetition could be avoided.


Critics of capitalism, like Marx, had always warned that crisis was unavoidable and the system was irrational. But the long century of industrial and material advance had eclipsed his influence despite the popularity of his analysis during the depression of the thirties that followed the crash of 1929 in North America. In the UK the depression measured in terms of very elevated unemployment already had begun by the late 1920s — for example, unemployment hit 12.7 % in 1926.It remained above 10 % until 1941. It peaked in Britain in 1932 at 22.5%(D.N.Ashton,Unemployment under Capitalism, table 2.3 p.32-33)


Keynes had written his General Theoryin part in the hope that it would provide the younger generation with a non-Marxist alternative to reforming capitalism and healing crises if not preventing them. He had also already in his earlier writing on probability constructed a theory that emphasized the role of uncertainty and risk (Carabelli, Skidelsky, Keynes‘sTreatise on probability; Treatise on Moneyand in his fundamental equations Keynes, Chorney)


Analysts like Charles Kindleberger, Joseph Schumpeter, Alvin Hansen, Charles Mackay, the author of the history of manias, popular delusions and mass hysterias, Extraordinary popular Delusions and the Madness of Crowdsand other contributors to the business cycle debates have always been aware of the bizarre and obsessional nature of the investment process in the hands of the Schumpeterian knights of creative destruction, the technological innovators and their allies. But the mainstream of the profession, attached as it is to the Walrasian equilibrium model and the Arrow Debreau model of perfect market behavior, has been very reluctant to accept any such synthesis.  The era of the Robber Barons (Josephson) made it clear that the classical model of frictionless perfect competition was a far cry from real world of monopolies, rent-seeking oligopolies and robber barons that dominated American capitalism at the turn of the nineteenth century and appear to have reappeared in the late twentieth century and gained strength in this one. (see Stiglitz, The Price of Inequalityand Robert Reich, Saving Capitalism) But despite these facts and circumstances, the classical school persisted in its argument granting scant recognition to critics and reformers.


Instead, in the late twentieth century the steadfast defenders of classical economics like Milton Friedman and the later Robert Lucas-Thomas Sargeant new classical macroeconomics of rational expectations rejected the insights of Keynes and regressed to the once discredited pre-Keynesian  classical view that markets always knew best and could solve all problems including unemployment. (Robert Lucas, Studies in Business Cycle theory, David Laidler, Fabricating the Keynesian revolution, Money and Macroeconomics; Barro, Macroeconomics;Thomas Sargeant, Rational Expectations and Inflation) In the face of rising unemployment and a financial panic and crash many of them  advocated balanced budgets and restrictions on government bailouts as the only way forward, predicting that acting otherwise would lead to stagnation and even stagflation if the near  trillion dollar  bailout was financed by a growth in high-powered money.


But when we look closely at the data this assertion of these dire consequences was contradicted in both North America and in Japan and to a lesser extent in the UK. In each of these jurisdictions governments and central banks relied upon substantial fiscal stimulus and substantial quantitative easing as well as a major bailout of the banks in both the U.S. and Canada.    A recent CCPA study reveals that Canada’s banks received $114 billion in cash and loan support from both the U.S. and Canadian governments during the 2008–2010 financial crisis. The study estimates that at some point during the crisis, three of Canada’s banks—CIBC, BMO, and Scotiabank—were completely under water, with government support exceeding the market value of the bank.(CCPA CCPA’s latest study, The Big Banks’ Big Secret: Estimating Government Support for Canadian Banks During the Financial Crisis.




In the Euro area we have had a different, more orthodox scenario. The European central bank and the EU followed a deliberately non-Keynesian, non-stimulative policy and relatively tight money, refusing to use quantitative easing until quite recently (Guardian, January 22, 2015  Quantitative easing around the world:lessons from Japan, UK and US, The European central bank finally launched a 1 trillion euro round of QE in  March 2015 years after other world central banks had embarked on monetary stimulus. Unlike in North America (with the possible exception of Quebec) it continued to firmly practicing austerity and following  rigid debt and deficit constraints despite the considerable evidence that such a policy would not work.( Despite all the critics who warned that such a policy package would not work and probably make things worse, the ECB and the EU and the IMF insisted on a severe policy of high interest rates, initially monetary contraction and fiscal austerity .(Varafoukas, Adults in the Room:My Battle with Europe‘s Deep Establishment,2017) The negative results are now clear. Greece, Spain and to a lesser extent Italy and France were the victims of this policy.


At the same time, however, the EU did bail out a large number of banks.During the financial crisis, 114 European banks benefited from government support in Europe.(SeeBank bailouts in Europe and bank performanceFinance Research Letters

Volume 22, August 2017, Pages 74-80

MariaGerhardtaRudi VanderVennetb)


The authors investigated ‘‘the financial condition of banks before and after receiving state support using logit regressions. (their) results indicate that the equity ratio, loan quality and bank size were the main determinants of bank bailout involvement.‘‘ However, the paper argues that ‘‘the aided banks hardly improved their performance indicators in the years following government aid, indicating that bailouts were not sufficient to restore bank health‘‘

The data reported in the appendix support the argument regarding the negative impact of austerity as opposed to QE and fiscal stimulus.  The UK, which remained outside of the Eurozone and preserved the independence of the Bank of England and was more willing to engage in in quantitative easing, had cut interest rates further to 0.25% after the Brexit referendum in 2016 and expanded QE to £435 bn from the earlier monthly purchases. (Katie Allen and Larry Elliott, Bank of England cuts interest rates to 0.25 % and expands QE. Aug.4, 2016.) The unemployment rate performed better in the UK during the recovery than it performed in most of the EU under the jurisdiction of the ECB.


Keynes had argued in the 1930s that, if faced by elevated unemployment, the central bank ought to push interest rates as low as possible,a la outrance,by ensuring a steady supply of high-powered money. Abba Lerner, after moving from his support of Hayek to being a member of Keynes’s younger circle, had developed the idea further in his work on functional finance and the economics of control. (Chorney 1984 The Deficit: Hysteria and the Current Crisis, CCPA; The Deficit and Debt Management: An Alternative to Monetarism, CCPA 1989) I had, along with John Hotson and Mario Secareccia, proposed a variant of this policy during the early 1980s. I called it the temporary monetization of a greater portion of the deficit and debt. I was denounced for this by mainstream neo-classical and classical rational expectations economists at the Bank of Canada as a fool and an inflationist. But events have largely proven me right. (Chorney) It is now a full decade after the crash and, in addition to the large bailouts, we have had a major increase in the balance sheet of the Fed and the  Bank of Canada and a full decade of very low interest rates by historical standards. What has been the impact upon inflation? Look at the data for Canadian inflation in the appendix. In May of 2011, inflation measured by the CPI peaked at 3.7 %. Core inflation was much lower. In only 9 of the 124 months since January 2008 has inflation been above 3%. In 11 of those months the rate has been below 2%; in 4 of the months it has been negative; in 14 of them it has been below 1%. Clearly, the policy was not inflationary in Canada. What about in the U.S.?



US inflation 2008–2018



Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Ave
2018 2.1 2.2 2.4 2.5
2017 2.5 2.7 2.4 2.2 1.9 1.6 1.7 1.9 2.2 2.0 2.2 2.1 2.1
2016 1.4 1.0 0.9 1.1 1.0 1.0 0.8 1.1 1.5 1.6 1.7 2.1 1.3
2015 -0.1 0.0 -0.1 -0.2 0.0 0.1 0.2 0.2 0.0 0.2 0.5 0.7 0.1
2014 1.6 1.1 1.5 2.0 2.1 2.1 2.0 1.7 1.7 1.7 1.3 0.8 1.6
2013 1.6 2.0 1.5 1.1 1.4 1.8 2.0 1.5 1.2 1.0 1.2 1.5 1.5
2012 2.9 2.9 2.7 2.3 1.7 1.7 1.4 1.7 2.0 2.2 1.8 1.7 2.1
2011 1.6 2.1 2.7 3.2 3.6 3.6 3.6 3.8 3.9 3.5 3.4 3.0 3.2
2010 2.6 2.1 2.3 2.2 2.0 1.1 1.2 1.1 1.1 1.2 1.1 1.5 1.6
2009 0 0.2 -0.4 -0.7 -1.3 -1.4 -2.1 -1.5 -1.3 -0.2 1.8 2.7 -0.4
2008 4.3 4.0 4.0 3.9 4.2 5.0 5.6 5.4 4.9 3.7 1.1 0.1 3.8
2007 2.1 2.4 2.8 2.6 2.7 2.7 2.4 2.0 2.8 3.5 4.3 4.1 2.8
2006 4.0 3.6 3.4 3.5 4.2 4.3 4.1 3.8 2.1 1.3 2.0 2.5 3.2
2005 3.0 3.0 3.1 3.5 2.8 2.5 3.2 3.6 4.7 4.3 3.5 3.4 3.4
2004 1.9 1.7 1.7 2.3 3.1 3.3 3.0 2.7 2.5 3.2 3.5 3.3 2.7
2003 2.6 3.0 3.0 2.2 2.1 2.1 2.1 2.2 2.3 2.0 1.8 1.9 2.3
2002 1.1 1.1 1.5 1.6 1.2 1.1 1.5 1.8 1.5 2.0 2.2 2.4 1.6
2001 3.7 3.5 2.9 3.3 3.6 3.2 2.7 2.7 2.6 2.1 1.9 1.6 2.8
2000 2.7 3.2 3.8 3.1 3.2 3.7 3.7 3.4 3.5 3.4 3.4 3.4 3.4


It is also clear that the Fed-financed bailouts did not result in inflation. Over the eleven-year period, inflation was negative in 9 of the months; it was under 1% in 22 of the months; under

2% in 77 of the 124 months. Clearly, inflation has not been a problem — contrary to the conventional wisdom. In fact, for much of the time the fear was further disinflation and even deflation.


The Owl of Minerva takes flight at dusk: The anti-Keynesian era is drawing to a close

(this section of the paper draws substantially from my web site papers that I presented at academic meetings in Chicago, New York, Montreal  and London over several years from 2008

The recent debate over debts, economic growth and the flawed work of two Harvard economists Carmen Reinhart and Kenneth Rogoff has in the clash of ideas, theories and interpreted facts yielded very bright sparks of enlightenment.(see my critique of Reinhart and Rogoff, Feb.17,2010.Misleading data on debts and growth. They correlate high debt levels with slow growth but have no discussion of causality which causes which. Rising unemployment and slower growth on account of excessively austere monetary and fiscal policy results in growing debt. That is why the only truly stimulative deficit policy is one that would calculate whether the passive deficit remains a deficit at high employment or becomes a surplus and not a deficit at full employment given the same tax and expenditure structure. See Robert Eisner‘s important work How Real is the Federal Deficit, pp.166 ff and chapter 14 See also Eisner on Lucas and Sargeant‘s critique of Keynesian strategies. ‘‘The deficits that Lucas and Sargeant saw in the seventies were not real deficits the combination of rising interest rates which lowered the market value of the debt held by the public, and the inflation lowering the real value all the more, converted the nominal budget deficits into real surpluses. Since Keynesian theory-and neoclassical theory as well…would predict that these surpluses would depress aggregate demand and hence increase unemployment, there is nothing in this economic history which can properly motivate rejection of the Keynesian model. Lucas and Sargeant had argued that the lesson of the seventies was that massive government budget deficits and high rates of monetary expansion were accompanied not by decreasing unemployment but by growing unemployment and growing inflation ‘‘)

It should now be clearer that the road to renewed prosperity cannot lie with a policy that has been discredited by what we have witnessed in Europe over the five years from 2008 to 2013. No one in their right mind could judge 27% unemployment in Spain and Greece, 17.5 % in Portugal and 11.0% unemployment in France, 11.5% in Italy and an overall unemployment rate of 12 .1% in Europe, as a policy success. Youth unemployment reached  59 % in Greece, 56% in Spain, 38.2 % in Portugal and 37.8 % in Italy ;the overall unemployment rate reached 5.2% in Japan.

As of January 2010, there was clear evidence of destabilizing policy failure. (data from Eurostat. Unemployment was 10 % in the EU 16 and 9.5% in the EU27) unemployment was 10 % in the U.S.; 8.5 % in Canada;10 % in France,7.6% in Germany;5.2 % in Japan.

From 2013 to 2018 the situation has improved somewhat. But it is still seriously damaging in Greece where unemployment is  at 20.8 % and youth unemployment is at 45 %. In Spain, the overall rate is 16.1 % and youth unemployment is still very high at 35 %. In France, unemployment is now at 8.8% with the youth rate at 21.5%. In Italy, the rate is 10.9 % and the youth rate is highly elevated at 32.8 %

The anti-Keynesian economics of the mainstream identified with fiscal orthodoxy and austerity.  Economists called this approach “new classical macroeconomics” to remind us of the pre- Keynesian classicals who had emphasized the perfect rationality of markets and their ability to recover from a crisis without government intervention and counter-cyclical deficit spending. This school and its solutions is now shown to be a chimera, just as it was during the 1920s and 30s. Increasingly, the long-silenced minority of economists who in the past were intimidated by the economics establishment and the control over grants, degrees and jobs have begun to question the wisdom of this now old orthodoxy that first arose in response to the monetarist counter-revolution led by Milton Friedman  and the neo-cons in the 1960s and 1970s.Young graduate students born after the Keynesians had been banished are keen to learn as much as possible about Keynesian doctrine and the new economics of lowering unemployment.

I know something of this counter-revolution because I was trained by Keynesians like Clarence Barber and Rubin Simkin at the University of Manitoba in the 1960s. Simkin was a Keynesian but he had also done graduate   work at the University of Chicago. Barber had done his graduate work at Minnesota and another, Cy Gonick, who had studied at Berkeley knew the work of Paul Sweezy and Hyman Minsky whose work predicted the kind of financial crisis and crash we experienced. I then was taught by monetarists like Harry Johnson (Johnson, Macroeconomics and Monetary theory) as well as more heterodox thinkers like A. Sen, M.Desai and Michio Morishima in the early 1970s at the LSE. During my career, I witnessed the triumph of the anti- Keynesians to the point that I eventually sought refuge in a department of political science. I also witnessed the beginning of the rise of Margaret Thatcher while I was a graduate student in the U.K. But Milton Friedman, Margaret Thatcher, and Harry Johnson, who coined the phrase the monetarist counterrevolution are all history now. (Friedman, A Monetary History of the United Stateswith Anna Jacobson Schwartz) It is more than forty years later.

An epoch is coming to a close. Like all epochs birthing a new one is often unclear, confusing and painful as it unfolds. But unfold it must. The intellectual supports for this old anti-Keynesian epoch are no longer viable. Inflation is nowhere the threat for the moment despite a substantial experiment with quantitative easing and deficit finance over a period of more than ten years. Though you would never know this from reading the business pages of the Globe and Mail,where deficit hysteria and inflation fear-mongering still rule the roost. The results of the new strategy have been less than that hoped for . But that is not because the theories are flawed but because adjustments are needed in the strategy.

The only possible threat of inflation comes from the rent-seeking of the oil cartel, which is about as far from the competitive market firm as one could imagine. We must also anticipate that the net demand for cash balances will rise during an unstable period so some of the stimulative effect is lost until confidence is more strongly restored. Pressing on the brakes through austerity while at the same time seeking to stimulate through deficit spending does not work efficiently and results in unnecessary frictions and too slow a process of recovery. Entrepreneurial animal spirits are reawakening. New innovations, products and technologies are developing. American real estate markets are slowly recovering. Distributional reforms are actively being discussed. Globalization and offshoring continue to be a complexity and a major challenge. The body politic is awake and increasingly vigilant. Some of the self- limiting and self-directing qualities of the market- driven cycle are returning.

The liberal humanist hour was nearly upon us. But Trumpian nationalism intervened and Tory xenophobia and austerity in the UK and elsewhere has thrown a major spanner in the works. (On austerity see Peter Goodman, Britain‘s Big Squeeze: In Britain austerity is changing everything, NYT May 27, 2018)The renewal of NAFTA appears to be less likely than we might have previously imagined. If it is not renewed than the question will be does Canada–US free trade continue or does only a variant of the auto pact continue. The outcomes will clearly affect the GDP in Canada as well as the unemployment rate and Canada would have to restructure its trading relationships to reduce the economic impact. Trump‘s vision threatens to push us in a regressive direction driven by the populist anger of those who have been hurt by globalization, outsourcing and improperly regulated trade liberalization and an excessive dose of divisive identity politics in Britain as well as in the US .In Britain despite significant QE ever since the crash inflation remains very low. In fact as of April the rate had dropped to 2.4% and the Governor Canadian Mark Carney warned that the Bank of England would not raise interest rates in a falling inflation environment. (GuardianMay 23, 2018) Also the challenge of environmentally sound economic growth is a growing challenge and must not be ignored.

Writers like Georgescu –Roegen, E.J. Schumacher,Barry Commoner, Rubin Simkin, Ronald Coase,Ralph Turvey,E.J.Mishan and Robert Dorfman ,  Herman Daly and John Cobb among others have developed an environmentally sensitive modification of macroeconomics in work published over the past 75 years . Typically they have used the microeconomics of welfare economics and discounting future costs and benefits to their present value(Daly&Cobb pp152ff) to analyse pollution costs, spill over effects,externalities and cost benefit analysis. So for example Daly and Cobb distinguish between short run analysis or Chrematistics which abstracts the market from the community and seeks its unlimited growth (p.158)  from Oikonomia which views the market from the perspective of the total needs of the community,including a healthy sustainable environment. Daly and Cobb argue that classical economic theory and Homo economicus derived from Adam Smith is based on an unrealistic individualism and a radical abstraction from social reality and love of others as well as oneself.(p.161) ‘‘In the real world‘‘ they argue, ‘‘the self contained individual does not exist‘‘…‘‘the social character of human existence is primary.‘‘They go on to discuss alternative measures to assess the welfare benefits of the GDP and how it needs to be modified to reflect human happiness and ecological sustainability.

Kate Raworth has recently had published her work Doughnut economicswhich explores the principle that economics ought to facilitate a social foundation of well being that no one should fall below and an ecological ceiling of planetary pressure that we should not go beyond . Between the two lies a safe and just place for all (Raworth p.11)  Beyond the outer ring of a doughnut lies critical planetary degradation. In the next concentric circle lies the ecological ceiling, moving further inward the safe and just place for humanity. Further inward lies the social foundation beyond it moving inward lies the zone of critical human deprivation.




Ecological ceiling———-.≥    —-≥Oplanetary degradation








Georgescu-Roegen was a pioneer in his discussion of the law of entropy and the environmental consequences of the development of raw materials and the production of energy. As Daly and Cobb put it ‘‘When nature and its resources for human use are viewed as a concentration of usable energy instead of as passive matter it will no longer be possible to ignore (his) fund flow model which …begins with the recognition that nature‘s contribution is a flow of low entropy natural resources.‘‘ With the addition of labour and capital wealth  is created from the natural resources. The labour and capital funds can be replaced but the resources are depleted and not replaced since their production may take 100s or even 1000s of years, p.197 Low entropy is replaced by high entropy material that can no longer be easily used.

In the light of these ecological critics and apparent potential changing planetary changes as well as the success of the QE experiment in monetary policy and the apparent problems with trade liberalization the aggregate demand function C+(I-S)+(G-Tx) +X-M needs to be modified to take into account both trade and the degree of monetization or QE of the deficit and debt, the prevailing structure   of interest rates and the environmental constraint. The production of environmental bads needs to be subtracted from the production of environmental goods. So we need to maximize C,I and G while minimizing idle savings. (M and Tx are more controversial variables. Keynesians believe that Taxation so long as it funds infrastructure, education, health care and social policy is a critical tool while supply siders and new classicals seek to reduce Tx preferring that the private sector stimulates spending and investment. They also believe that Savings automatically largely if not totally result in Investment whereas Keynesians see excessive savings intentions as a barrier to investment They also believe that I is larger if G is smaller unlike  Keynesians who are certain that Government spending stimulates I in most cases. Keynesians are divided about the importance of monetary policy but generally they prefer an accommodating monetary policy that targets low unemployment and strong growth. ( Note that a group of 61 economists has just signed a letter to the Finance minister Bill Morneau asking that the mandate of the Bank of Canada be formally broadened to include targeting low unemployment as well as stable low inflation,)Monetarists want steady predictable money supply that avoids triggering inflation.  And we need to pay attention to the prevailing rate of interest and degree of central bank purchase of debt. The demand for net cash balances should be as close to zero as possible since hoarded money accomplishes little. Government expenditure on renewing necessary infrastructure, investing in social policy and education of the work force needs to be a priority as well.

In an earlier paper presented to the Eastern Economics Association annual meeting in NY Feb 23 2001 I formulated a model as follows: dU =f(dM2b;di;dT⁄K;(X-M);dI;d(G-Tx);d (Bad-Bsd);dL⁄dLq;;P;e1,e2,e3;e*  min BADs and Max E where : dU rate of change in unemployment d M2b is rate of change in the broadly defined money stock; di the rate of change in real short term interest rate; dT⁄K rate of change in technological innovation  relative to the capital stock; X-M  the trade balance; dC rate of change in consumption; dG rate of change in Government expenditures; G-Tx+nbr the size of the government borrowing requirement where Tx is tax revenues and nbr non budget revenues; P is the policy regime in place; dBad-Bsd  is rate of change in central bank purchase of debt less central bank sale of debt; dL⁄dq ratio of rate of change in new labour mark entrants to rate of change in those leaving the labour market through death or retirement; e1 expectations about change in unemployment rate; e2 expectations about changes in  sales and business conditions; e3 expectations about sales in the financial markets and e* an estimated error factor. We need to add to this the ecological constraint discussed above and the negative consequences of trade liberalization if it creates outsourcing of jobs, or erodes wages and results in higher unemployment. For the last fifty years economists have documented the process of globalization and the role of the multinational corporation. From Stephen Hymer and Charles Kindleberger forward to contemporary theorists of uneven international development and trade the central role of the multinational corporation has been explored in a number of studies. (Hymer, The multinational corporation A Radical Approach; Kindleberger, International capital movements) the issue of relocation of labour and the role of branch plant has always involved the question of the impact  of outsourcing and movement of capital.


The employment multiplier needs to adjust for job losses through outsourcing of labour. The jobs created and those lost through technological innovation involving artificial intelligence needs to factored in as well. The older Keynesian model needs modification to reflect these changing realities of globalization. It need not be a zero sum game. The old classical model tended to neglect these aspects of economic reality and opt instead for a general equilibrium model that presumed that there would not be unwanted labour or frictions in the speed of wage adjustment and that trade always results in employment gains and that there is a perfectly competitive market in all spheres of the economy and as close to a perfect information system with which economic agents were all familiar. Rational expectations prevailed. Clearly this is not the case. Market imperfections and oligopoly power is much more common than is supposed. (See Joan Robinson on the economics of imperfect competition; Michal Kalecki and Joseph Stiglitz on rent seeking and Stephen Hymer on the nature of the modern multinational corporation.)

Pierre Fortin has also written on the misleading solutions offered by the Lucas Sargeant Prescott school that they claimed would correct for market imperfections and supply side shocks. For example, according to Fortin as they saw market prices for their products increase more slowly, they would incorrectly (but rationally) think this partly reflected that their own prices were losing ground relative to the general price level. This would lead them to expect a drop in profitability and, therefore, to reduce their levels of output and employment. Unemployment would rise. Just as in Friedman’s example, the employment situation would eventually return to normal when firms would realize that they had overestimated the general price level. Lucas’ theory of expectations formation, called rational expectations, was more sophisticated than Friedman’s. But his final diagnosis concerning the most important source of fluctuations in output and employment was the same as Friedman’s: erratic monetary policy generating confusion among economic agents. The same policy prescription naturally followed: prevent central bankers from doing harm by subjecting the growth of some monetary aggregate to a constant growth-rate rule. (Fortin Keynes Resurrected)

As Fortin explains it the monetarist new classical explanation for the prolonged depression of the 1930s was that ‘‘the workers kept rejecting job offers because they thought the wages were too low“. Then, as Fortin points out, new classical economists like Edward Prescott came up with a theory of business cycles that were driven not by monetary change but by technological shocks that affected the supply side rather than initially the demand side. Like the others he called for a neutral monetary policy and expressing confidence that over time the market would perform well and solve all problems. (Fortin)



As the old epoch recedes the new one is taking shape to replace it. But there is still substantial deficit and debt hysteria and a terrible attachment to damaging austerity. The global economy still needs a boost from the fiscal tax and expenditure side to enable it to do the necessary work. The threat that NAFTA will not be renewed makes the case for additional stimulus even more compelling. If this were to be done in the U.S. the unemployment rate would continue its downward path and likely stay below 4% for a period of time. In Canada we might also be able to lower the unemployment rate below 5 %. Currently it stands at 5.8 %


In North America, with the help of the Fed, the Bank of Canada and the Bank of Japan this kind of stimulus would be enough to assure the likelihood of the path to a faster and stronger recovery. If Europe were to switch from austerity to stimulus the path would be accelerated. According to several prominent members of the French Government, Chancellor Merkel was one of the last remaining holdouts opposed to a switch in policy. But she has lost ground to her coalition partner on the left and the right-wing parties have made important gains in Germany.There are big stakes in play here. Germany and France are at the heart of the European project. It is important for the decision takers to understand that the future of the EU common currency and the future well being of millions of Europeans as well as citizens from all over the globe are in play.

The pendulum is swinging. All it needs is one last powerful push in a Keynesian direction. If one examines the unemployment rates that prevailed five years after the crash, we can see how much damage these anti-Keynesian restrictive policies led to. Unemployment in Greece and Spain reached 27%, youth unemployment 45%. To call policies that led to these rates as sensible is mind-boggling. The rates in France and Italy were lower but still very elevated. Portugal also suffered from unemployment in excess of 12 %. (Ctri +Itri+ G-T +X-M + M(t-1)-Mt, in other words, the rate of change in monetization plays a role in the dynamic effectiveness of the I, C and net  X functions. dM dY is therefore not trivial and the impact it has had in bad economic times is positive. )Similarly to maintain and restore infrastructure it is conceivable to develop a a very long time horizon to finance these projects and to permit the central bank to hold some of the bonds that are issued. (See J.P.Morgan‘s role in rescuing the city of New York in 1907 in Bruner.) The general principal should be to include the social rate of return from investments in order to better calculate their contribution to the GDP and  the general welfare. In a similar fashion the degree of outsourcing and capital flow permissiveness is also a very significant factor in the net employment effect of the liberalization of trade on aggregate demand; in addition the ecological constraint feeds back into environmental quality. This crisis and its recovery path hence has had very revelatory consequences in a number of key areas.

Note the chart and table below which depicts U.S. unemployment from January 2008 to January 2017. Unemployment peaked in at ten per cent in October 2009  then remained very elevated above 9 % throughout the next 23 months until it dropped to 8.8% in October 2011 and then has steadily declined year after year although remaining above 6 % until September 2014 3 years later. Since then it has steadily fallen first below 5 % in January 2016 and then below 4 % in April 2018 where it reached 3.9 %.

So the severity of the recession and financial collapse was substantial. The recession itself that followed the crash lasted 18 months according to NBER beginning in December 2007 and ending in June 2009. The sub -prime mortgage crisis which like the recession itself had global consequences led to the collapse of Lehman brothers on September 15, 2008 and a subsequent major panic on the inert bank loan markets and eventually to a major series of bankruptcies of financial houses on Wall street, in the City of London and in France, Italy, Germany and Japan. The whole global landscape was dramatically altered and necessitated a multi trillion dollar bailout of the entire banking industry by government. Critics like Joseph Stiglitz and Robert Reich condemned this as socialism for the rich and we still can see the political consequences of this in global politics.

The NBER is the official arbiter of recessions in terms of defining their duration. The definition they rely upon is a s follows: the NBER defines a recession as ‘ a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income,employment, industrial production and wholesale-retail sales.‘business cycle dates are detrmined by the NBER dating committee under contract with the  department of Commerce.‘ (NBER)


US Unemployment U.S. Bureau of Labor statistics 2008 -2017



Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008 5.0 4.9 5.1 5.0 5.4 5.6 5.8 6.1 6.1 6.5 6.8 7.3
2009 7.8 8.3 8.7 9.0 9.4 9.5 9.5 9.6 9.8 10.0 9.9 9.9
2010 9.8 9.8 9.9 9.9 9.6 9.4 9.4 9.5 9.5 9.4 9.8 9.3
2011 9.1 9.0 9.0 9.1 9.0 9.1 9.0 9.0 9.0 8.8 8.6 8.5
2012 8.3 8.3 8.2 8.2 8.2 8.2 8.2 8.1 7.8 7.8 7.7 7.9
2013 8.0 7.7 7.5 7.6 7.5 7.5 7.3 7.2 7.2 7.2 6.9 6.7
2014 6.6 6.7 6.7 6.3 6.3 6.1 6.2 6.2 5.9 5.7 5.8 5.6
2015 5.7 5.5 5.5 5.4 5.5 5.3 5.2 5.1 5.0 5.0 5.0 5.0
2016 4.9 4.9 5.0 5.0 4.7 4.9 4.9 4.9 5.0 4.9 4.6 4.7
2017 4.8 4.7 4.5 4.4 4.3 4.3 4.3 4.4 4.2 4.1 4.1 4.1
2018 4.1 4.1 4.1 3.9




  • Data extracted on: May 22, 2018 (12:11:00 AM)


Labor Force Statistics from the Current Population Survey





The NBER keeps data on previous recessions, panics and depressions. In the 88 years since the great depression which lasted from August 1929 to March 1933-a period of 3 years and 7 months where unemployment peaked at 24.9 % and the decline in peak to trough in the GDP was minus 26.7%, the 2007-09 great recession was the longest and most severe event but for the great depression. One has to go back to the panics of 1907 involving the bank run on Knickerbocker trust and requiring the intervention of J.P.Morgan in the absence of a central bank to find an episode as severe. (Brunner&Carr, The Panic of 1907) So essentially the great recession was a twice a century event that brought western capitalism to the brink. Such a severe event called for drastic measures and by the stars of the conservative leaning new classical economists and rational expectationists the remedies were very drastic and they refused to abandon their commitment to laissez –faire and monetarist orthodoxy to embrace them.


But just as the crash and great recession posed a systemic challenge to orthodoxy they produced a golden opportunity for post Keynesian critics and Keynesians and environmentalist to fashion a new progressive synthesis of policy and theory which will be far better than what is now lying in tatters amidst the ruins of unscientific theory.



About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
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