Roubini’s conceptual apparatus
for addressing the crisis

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.

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