There are two currents of interpretation of the present crisis. The first emphasizes a deficiency of the regulatory framework. It argues that it was such deficiency that ultimately led to the excess of leverage in the financial system. The explosion of ingenuity that followed the development of contingent contracts, the so called "derivatives", and the securitization of credits transformed the financial system from a relationship oriented system into a market transaction oriented system. It should have been more and better regulated in order to avoid the resulting excesses. The second current emphasizes the presence of large international macroeconomic imbalances. Obviously both interpretations are at least partially correct, but they are above all complementary. The macroeconomic imbalance would not have been so deep and persistent without the extraordinary development of the financial market. Indebtedness and leverage would not have reached such extremes in the world without the international macroeconomic imbalance. To accept that both interpretations are complementary does not necessarily lead to the conclusion that to redesign the regulatory framework is as important as to find a way to reverse the international macroeconomic imbalance.
He notes, as has Bruce, that much of the reason for that imbalance was the withdrawal of capital from the BRICs in previous crises, and the insistence of the IMF on restrictive monetary policies in these countries to "restore confidence" of their soundness in the eyes of the international capital markets. The BRICs concluded that they could only participate in the international markets provided they accumulated large holdings of reserve currencies and forewent stimulative economic policies in their own countries, though it meant that critical social infrastructure needs went unfulfilled. This prevented them from engaging in needed stimulative spending and still tends to hold down such spending. But as commenters noted, their relative size, anyway, would limit the impact of their spending on the world economy.
There is a major difference between the present conditions and those prevailing at the time Keynes elaborated his theses. The General Theory is of 1936. Before that, from 1932 on, sketches of the argument could be found in his essays.[3] In 1932, the economy was still in profound depression, but - as known today - due in a large extent to the errors of monetary policy, the excess of debt of the private sector had been eliminated by the collapse of the financial system. The generalized bankruptcy of banks and firms solved the problem of excessive indebtedness. Banks, enterprises and households were broken, but with no debts. The costs were dramatic, but the excess of debt disappeared. The fact that the mistakes of 1929 have not been repeated, lead to circumstances far different from those of 1932. Financial collapse was avoided and despite the severity of the recession, we are still far from the thorough disorganization of the economy and massive unemployment -close to 30% of the labor force - of the Great Depression. The economy, however, almost two years after the beginning of the crisis, continues to be overwhelmed by unredeemable debts. As long as households and firms continue to bear the brunt of excessive debt, they will try to reduce expenditures and increase savings. Until debt is reduced to levels which are perceived as reasonable, the private sector expenditure will be exceptionally low. After the Great Depression, in the early thirties, there was a lack of demand because there was no economic activity and no income. Today, the lack of demand is the result of the exceptionally high rate of savings required to bring back private debt to reasonable levels. These are very different situations. -Skip- It was not Keynes, but Irving Fisher, the American economist who lived between 1867 and 1947, who did the most insightful analysis of economies in deflation, paralyzed by excess debt. Keynes' analysis dealt with how to reactivate an economy where debts had been decimated by the depression. Keynes, at least the one of the General Theory, is the economist of the post-depression period. Fischer is the great analyst of depressive periods in themselves, when the question of excessive debt and deflation prevails.[4] Fischer studied the depressions of 1837 and 1873, as well as the one from 1929 to 1933. He argued that neither monetary policy nor fiscal policy is able to stimulate the economy while excessive debt remains present. An idea of the relative dimensions of the current debt problem can be grasped by the fact that, in 1929, the total of American debt was 300% of GDP; it reached almost 360% of GDP at the end of 2008, after staying between 130% and 160% from the beginning of the fifties to the end of the eighties. Ben Bernanke, the Fed chairman and an academic with relevant contribution to the understanding of depression periods, is well aware of the difficulties to escape from the deflation trap. When visiting Japan some years ago, he remarked that the best way to get out of deflation is not to get into it.
-Skip-
It was not Keynes, but Irving Fisher, the American economist who lived between 1867 and 1947, who did the most insightful analysis of economies in deflation, paralyzed by excess debt. Keynes' analysis dealt with how to reactivate an economy where debts had been decimated by the depression. Keynes, at least the one of the General Theory, is the economist of the post-depression period. Fischer is the great analyst of depressive periods in themselves, when the question of excessive debt and deflation prevails.[4] Fischer studied the depressions of 1837 and 1873, as well as the one from 1929 to 1933. He argued that neither monetary policy nor fiscal policy is able to stimulate the economy while excessive debt remains present. An idea of the relative dimensions of the current debt problem can be grasped by the fact that, in 1929, the total of American debt was 300% of GDP; it reached almost 360% of GDP at the end of 2008, after staying between 130% and 160% from the beginning of the fifties to the end of the eighties. Ben Bernanke, the Fed chairman and an academic with relevant contribution to the understanding of depression periods, is well aware of the difficulties to escape from the deflation trap. When visiting Japan some years ago, he remarked that the best way to get out of deflation is not to get into it.
