The core of Nouriel Roubini’s brilliant book “Crisis Economics” (2011) may be summed up to the effect: an important tip on how to rescue the world economy (and thereby Europe’s economic integration) may come from an unexpected source. To wit, from combining two approaches, so far regarded as antythetical to each other: that of Hayek (with the whole Austrian School) and that of Keynes. Roubini is the one who recognized that they can and should be linked into a coherent system of thought.
This is convincingly expounded in Chapter 2, Section “To Austria and back” (p.28), of the said volume. The key to such a synthesis lies in distinguishing between long-term strategy and short-term strategy. We read in that Section: “Joseph Schumpeter [a prominent Austrian economist] developed a powerful theory of entrepreneurship that is often distilled down to a pair of powerful words: creative destruction“; this is a sharper version of some views of Hayek. Roubini continues as follows.
In Schumpeter’ worldview, capitalism consists of waves of innovation in prosperous times, followed by a brutal winnowing in times of depression. This winnowing is to be neither avoided nor minimized: it is a painful but positive adjustment, whose survivors will create a new economic order.
In principle, Roubini approves such a harsh approach. This implies that no actions should be taken by governments or central banks to rescue entrepreneurs who collapse for their recklessness; “in principle” means here “in long distance”. However, this position – claims Roubini – should be completed with the following consideration.
The Austrian approach is misguided when it comes to short-term policies. As Keynes recognized, in the absence of government intervention, a crisis caused by financial excesses can become an outright depression, and what begins as a reasonable retreat from risk can turn into a rout. When the animal spirits [i.e., businessmen’ bold initiatives resulting in free market] of capitalism vanish, the creative destruction hailed by the Austrians can swiftly turn into a self-fulfilling collapse of private aggregate demand. As a consequence, distressed but still-solvent firms, banks, and households can no longer gain access to the credit necessary for their continued survival. It s one thing if truly insolvent banks, firms, and individual households go under; it s another altogether when innocent bystanders to an economic crisis are forced into bankruptcy because credit dries up.
In order to prevent this kind of collateral damage, it makes sense to follow the playbook devised by Keynes in the short term, even when the underlying fundamentals suggest that significant portions of the economy are not only illiquid but insolvent. In the short term, it is best to prevent a disorderly collapse of the entire financial system via monetary easing and the creation of bulwarks: via lender-of-last-resort support, for example, or capital injections into ailing banks. It is also best to prop up aggregate demand through stimulus spending and tax cuts. Doing so will prevent a financial crisis from turning into something comparable to the Great Depression.
To sum up, Roubini’s conceptual project consists in reconciling the both opposing theories by assigning each of them a different role in the fight with the global crisis. These theories prove to complete each other, if reasonably applied in changing circumstances. Hence, the lesson to be learnt is to the effect that both sets of proposals should be carefully considered, not only by professionals alone, but by all responsible citizens as well.
Once more lesson is worth considering, namely the occurence of the word “reckoning” by the end of the section in the following context: “a necessary reckoning must take place over the longer term in order to achieve a return to prosperity”. The term “reckoning”, which means computation, is crucial for economics, and for understading the mechanics of crises, as discussed in the post III on cognitive power of free market.
It would be nice to sum up such a solemn discourse in a more relaxed mood. Fortunately, for this purpose we got a hilarious piece of music and piece of verse in the best rap style. One in which Keynes’ and Hayek’s eagerness in defending their points gets shown in a much funny way. It is the video “Fear the Boom and Bust“. The title goes to the heart of crisis economics, since excessive and euphoric booms, called bubbles, do lead to depressing busts. After such a bust may come recovery, but the whole process is very costly. The Austrians, and mostly Hayek, have become classics in studying such cycles. Thus that funny film deals with serious economic issues.
A note about the book and Nouriel Roubini. The book is co-authored by Stephen Mihm. It bears the subtitle “A crash course in the future of finance”. At the cover, the name of Roubini is followed by the phrase “The seer who saw it coming”, taken from a review in “The New York Times”. In fact, Roubini was among those few, who have foreseen the disaster, having been much ahaed in spotting this event. This is why his opinion and his analysis weighs now so heavily.