Policy Research in Macroeconomics

Lessons to be learnt

This is the first of two posts on the current crisis by Professor Massimo Amato, of Bocconi University, Milan.

Well before the health emergency is over, the coronavirus crisis has already begun to produce devastating effects on the economy.

This happens not only because the only accepted strategy, that of a lockdown, involves a strong slowdown in economic activity, but because the exposure of the economic system to expectations is such that the medium-term effects are so anticipated that they begin to occur already today. Instead of producing antibodies, the current system spreads the instability virus.

And so, in addition to addressing the health problem in the proper sense, we also have to protect the economic and financial system before the level of infection is completely out of control.

All this, however, tells us only one thing, namely that the health crisis, “exogenous” to economic operations in the proper sense, is grafted onto an endogenous weakness.

A weakness which, it should be said clearly, is the necessary fruit, even if not necessarily wanted in its most devastating effects, of a patient work of de-structuring. Indeed, as Pierre Legendre would say, a work of dis-institution.

For more than thirty years, with a regularity worthy of better cause, and fuelled by a complacency that often removed doubts by silencing the doubters, a dogmatic notion of economics was built that entrusted to “markets”, and in particular to financial markets, the role of absolutely efficient operators. And of ultimate decision-makers in allocation decisions.

Now if there is one thing that “the markets” show in these days and hours, it is that the rational decisions that they were already struggling to take well in “normal” situations, now are completely out of their reach.

Efficient market doctrine

The “uncertainty effect” has been evoked, but this is not a sufficient explanation. What is at stake these days, is not one effect among many, but the return of a fundamental uncertainty that we wanted to remove by hiding it behind the doctrine (I explicitly do not say theory) of efficient markets.

Markets are not absolutely efficient because they cannot be a response to fundamental uncertainty. This means that to operate in a relatively efficient way they need to relate to a “fixed point”. And this fixed point is external to them, in the sense that they cannot give it to themselves. Markets are not the baron Münchhausen, and they do not come out of the mud by pulling themselves up by their own hair. In fact, the more they try to do it, the more mud they create.

The limits of central banks

But central banks are not Münchhausen either. In these days, they are insistently (and within the limits of the emergency with good reason) called upon to “reassure” the markets with injections (better, with drips) of the barbiturate they have plenty of since they do not simply distribute it, but directly produce it, i.e. liquidity. But, as the best central bankers and the best mainstream representatives have been saying for some time now, monetary policy as such is less and less effective. Central banks can certainly contain the damage, and in this sense, they must do “whatever it takes”, without skimping on the quantities. However, whatever it may take, they alone do not produce any structural adjustments to the state of long-term expectations.

It would be funny, were it not for the sadness of the situation, to observe how the clumsy priests of “there is no money” to do things, are now inciting central banks to “print money” “like there’s no tomorrow”.

But tomorrow there is, and while the emergency responses can certainly help us to see it (tomorrow I mean), they are in themselves neither the way to face it, nor to postpone it sine die.

If we believe that (provided that we manage to get out of it alive) we will not be able to escape from this crisis unless we enter a new and unknown world, then we must distinguish well, right now, between the immediate actions to contain the emergency and the actions aiming at rebuilding .

Democracy at stake

The same applies here that applies to the temporary restrictions of individual freedom in the name of collective security: they may perhaps make sense in a fixed term, but they cannot, and must not, become permanent, because democracy is at stake.

As far as politics is concerned, history would indicate that the concentration of powers in the “state of exception” is an institution which, while remaining dangerous in itself, may perhaps make sense if it has a strictly regulated time. I repeat: maybe.

In economics, however (with all due respect to economists who, after having dogmatically assumed the self-regulation capacities of free market, yearn in difficult times for the “benevolent dictator”), things are still different. And the first thing we have to do, if we want to speak seriously, is to avoid believing that omnipotent economic institutions can and above all should exist.

This has long been believed for markets, to the point of believing that it was not only true, but also good, that they imposed “discipline” on debtors, even and especially the public ones. Now that for the markets “it doesn’t look good”, there is no need to transfer this same belief to central banks, as the same people who have just stopped idolizing the markets often do just as idolatrously. Central banks are invoked as if their action had no limits. It does have limits, however, limits that manifest themselves even before the eventual ineffectiveness of CB’s action.

From ‘omnipotence’ to coordination

The renunciation of the “omnipotence hypothesis” opens a new scenario, both from a conceptual and institutional point of view: the one in which the coordination of the relative impotence of all the actors of the system becomes the way not to remove uncertainty, but to deal with it firmly, i.e. in a way not always on the verge of creating more instability than it can temporarily reduce. That is to say, in a positive way, in order to strengthen the tightness of the system and its component parts.

As a perspective, giving up omnipotence means assigning preventive limits to economic action, economic growth, accumulation and profit. But these limits are the limits that make cooperative solutions of competitive games much more interesting than competitive solutions.

Let us then review the relative impotences that positively affect the actors of the system.

Markets: it comes to fully recognizing their inability to work out their own “benchmarks”, or even more precisely their “fixed points”, to recognising that when they try to work them out, in an attempt to protect themselves from risk, they create risk. Markets can price all risks, except systemic risk, to which it does not correspond a price because in this case there is nothing to sell, but rather a cost of capital, in order to protect oneself from it.  Markets can produce all kinds of assets, except safe assets.  And above all, the markets cannot eliminate fundamental uncertainty, to which there is nothing to oppose, neither price nor capital, if only a “healthy and robust constitution”, both institutional and psychological.

Central banks: they are specifically thought of for setting the reference rate. But the experience of these years has shown that the objectives of central banks certainly do not clash with limits as to the creation of new quantities of money (since these limits simply do not exist) but with central banks’ inability to efficiently control the channels of transmission of the money issued. With reference to the current situation: the new liquidity injections that are taking place could lead to either inflation or a continuing deflation.

The states: it is clear that they must be able to recover those margins of action and of indebtedness which they have more or less voluntarily renounced to. But even in this case the margins of action of the states stop at their borders, and if it is clear that we have to rethink many things about the international division of labour, of international trade, in short, of globalization, no state can think of closing in on itself.

The legacy and the challenge

These thirty years, disastrous and to be forgotten, leave us a legacy that cannot however be bypassed. The international dimension will have to be reviewed, also in light of the blows it will receive from the crisis, but it cannot be eliminated. Just as the role of capital markets cannot be completely eliminated. We must avoid thinking in terms of polarizations, opposing market and planning as if they were positions to be accepted or rejected unconditionally.

Professor Amato is the co-author (with Luca Fantacci) of “The End of Finance” (Polity) and “Saving the Market from Capitalism: Ideas for an Alternative Finance” (Palgrave). You can follow him on twitter at @MassimoAmato9

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