Scott Sumner’s three most recent posts (here, here, and here)have been really great, and I’ld like to comment on all of them. I will start with a comment on his post discussing whether the free market economy is stable; perhaps I will get around to the other two next week. Scott uses a 2009 paper by Robert Hetzel as the starting point for his discussion. Hetzel distinguishes between those who view the stabilizing properties of price adjustment as being overwhelmed by real instabilities reflecting fluctuations in consumer and entrepreneurial sentiment – waves of optimism and pessimism – and those who regard the economy as either perpetually in equilibrium (RBC theorists) or just usually in equilibrium (Monetarists) unless destabilized by monetary shocks. Scott classifies himself, along with Hetzel and Milton Friedman, in the latter category.
Scott then brings Paul Krugman into the mix:
Friedman, Hetzel, and I all share the view that the private economy is basically stable, unless disturbed by monetary shocks. Paul Krugman has criticized this view, and indeed accused Friedman of intellectual dishonesty, for claiming that the Fed caused the Great Depression. In Krugman’s view, the account in Friedman and Schwartz’s Monetary History suggests that the Depression was caused by an unstable private economy, which the Fed failed to rescue because of insufficiently interventionist monetary policies. He thinks Friedman was subtly distorting the message to make his broader libertarian ideology seem more appealing.
This is a tricky topic for me to handle, because my own view of what happened in the Great Depression is in one sense similar to Friedman’s – monetary policy, not some spontaneous collapse of the private economy, was what precipitated and prolonged the Great Depression – but Friedman had a partial, simplistic and distorted view of how and why monetary policy failed. And although I believe Friedman was correct to argue that the Great Depression did not prove that the free market economy is inherently unstable and requires comprehensive government intervention to keep it from collapsing, I think that his account of the Great Depression was to some extent informed by his belief that his own simple k-percent rule for monetary growth was a golden bullet that would ensure economic stability and high employment.
I’d like to first ask a basic question: Is this a distinction without a meaningful difference? There are actually two issues here. First, does the Fed always have the ability to stabilize the economy, or does the zero bound sometimes render their policies impotent? In that case the two views clearly do differ. But the more interesting philosophical question occurs when not at the zero bound, which has been the case for all but one postwar recession. In that case, does it make more sense to say the Fed caused a recession, or failed to prevent it?
Here’s an analogy. Someone might claim that LeBron James is a very weak and frail life form, whose legs will cramp up during basketball games without frequent consumption of fluids. Another might suggest that James is a healthy and powerful athlete, who needs to drink plenty of fluids to perform at his best during basketball games. In a sense, both are describing the same underlying reality, albeit with very different framing techniques. Nonetheless, I think the second description is better. It is a more informative description of LeBron James’s physical condition, relative to average people.
By analogy, I believe the private economy in the US is far more likely to be stable with decent monetary policy than is the economy of Venezuela (which can fall into depression even with sufficiently expansionary monetary policy, or indeed overly expansionary policies.)
I like Scott’s LeBron James analogy, but I have two problems with it. First, although LeBron James is a great player, he’s not perfect. Sometimes, even he messes up. When he messes up, it may not be his fault, in the sense that, with better information or better foresight – say, a little more rest in the second quarter – he might have sunk the game-winning three-pointer at the buzzer. Second, it’s one thing to say that a monetary shock caused the Great Depression, but maybe we just don’t know how to avoid monetary shocks. LeBron can miss shots, so can the Fed. Milton Friedman certainly didn’t know how to avoid monetary shocks, because his pet k-percent rule, as F. A. Hayek shrewdly observed, was a simply a monetary shock waiting to happen. And John Taylor certainly doesn’t know how to avoid monetary shocks, because his pet rule would have caused the Fed to raise interest rates in 2011 with possibly devastating consequences. I agree that a nominal GDP level target would have resulted in a monetary policy superior to the policy the Fed has been conducting since 2008, but do I really know that? I am not sure that I do. The false promise held out by Friedman was that it is easy to get monetary policy right all the time. It certainly wasn’t the case for Friedman’s pet rule, and I don’t think that there is any monetary rule out there that we can be sure will keep us safe and secure and fully employed.
But going beyond the LeBron analogy, I would make a further point. We just have no theoretical basis for saying that the free-market economy is stable. We can prove that, under some assumptions – and it is, to say the least, debatable whether the assumptions could properly be described as reasonable – a model economy corresponding to the basic neoclassical paradigm can be solved for an equilibrium solution. The existence of an equilibrium solution means basically that the neoclassical model is logically coherent, not that it tells us much about how any actual economy works. The pieces of the puzzle could all be put together in a way so that everything fits, but that doesn’t mean that in practice there is any mechanism whereby that equilibrium is ever reached or even approximated.
The argument for the stability of the free market that we learn in our first course in economics, which shows us how price adjusts to balance supply and demand, is an argument that, when every market but one – well, actually two, but we don’t have to quibble about it – is already in equilibrium, price adjustment in the remaining market – if it is small relative to the rest of the economy – will bring that market into equilibrium as well. That’s what I mean when I refer to the macrofoundations of microeconomics. But when many markets are out of equilibrium, even the markets that seem to be equilibrium (with amounts supplied and demanded equal) are not necessarily in equilibrium, because the price adjustments in other markets will disturb the seeming equilibrium of the markets in which supply and demand are momentarily equal. So there is not necessarily any algorithm, either in theory or in practice, by which price adjustments in individual markets would ever lead the economy into a state of general equilibrium. If we believe that the free market economy is stable, our belief is therefore not derived from any theoretical proof of the stability of the free market economy, but simply on an intuition, and some sort of historical assessment that free markets tend to work well most of the time. I would just add that, in his seminal 1937 paper, “Economics and Knowledge,” F. A. Hayek actually made just that observation, though it is not an observation that he, or most of his followers – with the notable and telling exceptions of G. L. S. Shackle and Ludwig Lachmann – made a big fuss about.
Axel Leijonhufvud, who is certainly an admirer of Hayek, addresses the question of the stability of the free-market economy in terms of what he calls a corridor. If you think of an economy moving along a time path, and if you think of the time path that would be followed by the economy if it were operating at a full-employment equilibrium, Leijonjhufvud’s corridor hypothesis is that the actual time path of the economy tends to revert to the equilibrium time path as long as deviations from the equilibrium are kept within certain limits, those limits defining the corridor. However, if the economy, for whatever reasons (exogenous shocks or some other mishaps) leaves the corridor, the spontaneous equilibrating tendencies causing the actual time path to revert back to the equilibrium time path may break down, and there may be no further tendency for the economy to revert back to its equilibrium time path. And as I pointed out recently in my post on Earl Thompson’s “Reformulation of Macroeconomic Theory,” he was able to construct a purely neoclassical model with two potential equilibria, one of which was unstable so that a shock form the lower equilibrium would lead either to a reversion to the higher-level equilibrium or to downward spiral with no endogenous stopping point.
Having said all that, I still agree with Scott’s bottom line: if the economy is operating below full employment, and inflation and interest rates are low, there is very likely a problem with monetary policy.
Uneasy Money 
David, perhaps you’re familiar with the greatest comment section on the internet? It’s a response to this, from Greenspan:
> Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.
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“We just have no theoretical basis for saying that the free-market economy is stable.”
“The existence of an equilibrium solution means basically that the neoclassical model is logically coherent, not that it tells us much about how any actual economy works.”
I agree.
But how is “stable” defined anyway?
Is a recession every 5 – 10 years and a major crisis/prolonged slump every 30 – 50 years indicative of “stability”?
Does the reality of economic history (recessions/depressions) suggest equilibrium is always and everywhere present?
Perhaps recessions/depressions are equilibrium states?
Why fuss about equilibrium?
As far as I am concerned, Neoclassical economics is bullshit and is useless in dealing with economic reality.
(My apologies, David, I find no better way of expressing my opinions on the matter.)
“This is a tricky topic for me to handle, because my own view of what happened in the Great Depression is in one sense similar to Friedman’s – monetary policy, not some spontaneous collapse of the private economy, was what precipitated and prolonged the Great Depression…”
It always puzzles me how we always want to ascribe to a particular economic phenomenon a singular cause related to a unique event (e.g. monetary policy). The Great Depression was a complex process – it had an economic/financial context and proceeded on inevitable lines once certain events fell into place – and was exacerbated by policy failure.
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Great post, but I don’t like very much the Sumner’s posts. I agree that a monetary policy based on NGDP is not a guarantee of estability, as any one else. I’m afraid that Sumner obvious dinaxil markets, which never will be stable only with MP. I like the description of Leivonhufvud.
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Re: “There are actually two issues here. First, does the Fed always have the ability to stabilize the economy, or does the zero bound sometimes render their policies impotent? In that case the two views clearly do differ. But the more interesting philosophical question occurs when not at the zero bound, which has been the case for all but one postwar recession. In that case, does it make more sense to say the Fed caused a recession, or failed to prevent it?”
It seems to me that this misses the point. Of course the Fed caused the recession when it increased rates leading up to the crash. How can anyone deny that obvious fact? The real question is whether or not there is anything the Fed could have done to avoid a recession once non-federal debt had increase to 318% of GDP in a situation in which that debt had been created in the midst of a massive mortgage fraud that led to there being $11 trillion worth of mortgages at the heart of the $46 trillion worth of non-federal debt that existed in 2007—mortgages on properties the prices of which had been inflated by the housing bubble that the subprime mortgage fraud had helped to create. ( http://www.rweconomics.com/htm/WDCh10e.htm ) This begs the question: Is there anything the Fed could have done to have kept this sort of thing from happening?
Twice during the past one hundred years the world economy has been driven to the zero lower bound: once following the Crash of 1929 and again following the Crash of 2008. The economic, social, and political upheaval created by the Great Depression following the Crash of 1929 eventually led to World War II, and the fallout from the current economic slump is in the midst of playing itself out in a way that does not seem to hold much promise for the future.
It may be an interesting philosophical question to discuss if it makes more sense to say the fed caused a recession, or failed to prevent it, but this is of no practical importance. The substantive questions that come to the fore when faced with the kind of situation we face today are those concerned with how to contain the economic, social, and political upheavals created by the fallout from the kind of catastrophe we are in the midst of, and how to avoid this kind of catastrophe in the future. ( http://www.rweconomics.com/LTLGAD.htm ) It is only after we have answered these kinds of questions that the question as to whether the Fed causes or fails to prevent a recession becomes relevant.
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The descriptor ‘The Free-Market Economy’ is so vague that it is useless to discuss whether that to which applies is “stable.” For example, the monetary system is not specified (except that it must be “free”). Furthermore, *stability* is a matter of degree. An actual economy is never in perfect equilibrium. How much deviation from perfection is compatible with “stability”?
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Very good post. I am not sure that Friedman regarded the k percent rule as a golden bullet, more like the lesser of evils, relative to discretionary policy.
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Nice post. Yes, low inflation and low growth suggest tight money.
On a practical level, I think the economy is much less inflation-prone than 40 years ago.
But why?
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Having read through Scott Sumner’s “The real problem was Nominal” I think I should elaborate on my comment above and note that I fully agree with you in that I think he is missing something that is very important.
Deregulation of the financial system in the 1970s through the early 2000s led to a series of epidemics of fraud that accompanied the Junk Bond Bubble, the Savings and Loan Crisis, and the Dotcom and Telecom Bubbles leading up to the massive Subprime Mortgage Fraud of the early 2000s.
Housing prices increased in every quarter from 1998-1 through 2006-1 and had increased 61% by 2004 when the Fed began to tighten and by 79% when the bubble burst in 2006. At the same time total non-federal debt had increased to 280% of GDP by 2004, 299% of GDP by 2006, and peaked at 321% of GDP in 2008. As can be seen in Figure 10.1 in http://rweconomics.com/htm/WDCh10e.htm and Figure 12.1 in http://www.rweconomics.com/LTLGAD.htm these were historic highs.
And as I have noted above, by 2007 there was $11 trillion worth of mortgages at the heart of the $46 trillion worth of non-federal debt that existed—mortgages on properties the prices of which had been inflated by the housing bubble that the Subprime Mortgage Fraud had helped to create. In addition, there were some $500 trillion worth of derivative contracts outstanding in 2007 that had been created in the absence of any kind of government regulation that would ensured the viability of these contracts. At the same time leverage in financial institution had reached historic levels.
While it seems obvious to me that the Fed did, in fact, bring on the recession that began in 2007 in the United States as it tightened credit from 2004 through 2007 in an attempt to put a break on the housing market, the question I raised avove is whether or not there is anything the Fed could have done to have avoided, as opposed to have simply postponed a recession in this situation? I raised this question because it seems to me that the imbalances in the system were so great by 2004 that a financial collapse and a concomitant recession were inevitable whatever the Fed did with its monetary policy. The only question, as I see it, was when would it occur and how bad would it be.
Sumner seems to argue in his paper, “The real problem was Nominal”, that the Fed could have avoided the ensuing recession if it had targeted NGDP rather than whatever it was in fact targeting during the lead up to the crisis in 2008. It’s not at all clear to me that the Fed can, in fact, achieve the kind of control over NGDP that Sumner seem to think it can achieve, but, in any event, I just don’t see how that is supposed to work with the wholesale fraud, leverage, and lack of regulation in the derivative markets that existed in the financial system leading up to the crisis in 2008. It seems to me that if the Fed had continued to loosened credit leading up to 2008 the insanity in the financial markets would have gotten worse as non-federal debt relative to GDP, leverage in the financial system, and unsound financial derivatives grew to even greater astronomical levels than actually occurred. How was this supposed to end if the Fed had continued to feed the financial system with looser credit?
Sumner seems to be arguing that the inflation that would have resulted from the Fed’s feeding the financial system would have solved the problem. Relying on continual or possibly accelerating inflation to solve economic stability problems appears to be a contradiction in terms since inflation can be as destabilizing as recessions. This would be trading one kind of economic instability (recession) for another (inflation), and there is no guarantee that, in the end, the resulting inflation wouldn’t have lead to an even worse recession if the financial insanity at the beginning of the decade had not been nipped in the bud through tighter monetary policy when it was.
I would think that the only way to provide true economic stability is to avoid the kinds of financial excesses that have existed since we began to deregulate the financial system in the 1970s, and the way to do this is through strict government reregulation with regard to leverage, reserve and margin requirements, clearing houses, etc.
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” I would think that the only way to provide true economic stability is to avoid the kinds of financial excesses that have existed since we began to deregulate the financial system in the 1970s, and the way to do this is through strict government reregulation with regard to leverage, reserve and margin requirements, clearing houses, etc. ”
Agree 100 per cent.
Americans are too close to their own very large system to realize just how phenomenally dysfunctional the regulatory institutional framework is for the most advanced economy in the world.
The first problem is the mistake of vesting too much regulatory responsibility with the Federal Reserve.
That is a continuing recipe for lack of effective focus on the regulatory issues. Central banks should run monetary policy and provide input to regulatory policy – not be responsible for it.
But that problem is centered within a host of other regulatory dysfunctions, including the wide gap between bank and non-bank oversight functions.
Hint:
have a look north to see more co-ordinated regulation in action, including actions on the mortgage front that progressed in successive fine tuning iterations during and after the financial crisis. It’s not perfect, but its an infinitely better effort.
(meanwhile, American hedge funds are busy being wrong in their short positions in Canadian banks over many years – a complementary symptom of a sort)
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Scott, Thanks for sharing. I can’t remember if I ever saw that before. There is an invisible hand and we have to rely on it for many things, but we are constantly learning more about how and when it functions well and when it functions badly and what can be done to make it work better. We still have a lot to learn.
Miguel, Thanks.
George, Obviously a crisis doesn’t happen in a vacuum that makes the financial system very fragile. But there was a path that could have been followed that would have avoided the crisis and kept the system from breaking down. The Great Depression and the Little Depression did not have to happen, Hawtrey and Cassel warned against exactly the mistakes made by the Bank of France and by the Fed in 1928-29, and the misguided focus of the Fed on rising energy prices in the spring and summer of 2008 when the economy was already contracting and unemployment rising was not inevitable.
Philo, You are right that I am using vague terms, but I still think that they convey enough meaning for people to be able to figure out what I was talking about.
Scott, I agree with you to some extent, but Friedman’s support for the k-percent rule was informed by his belief in a stable demand for money, a belief that a self-described empiricist like Friedman should never have talked himself into.
Benjamin, Good question. We are still trying to figure it out.
George, Housing prices peaked in 2006, the recession started at the end of 2007. The crisis did not start till September of 2008, after almost a year of steadily tightening money by the Fed in the face of a deteriorating economy with falling housing prices. Your deterministic argument that the crisis was inevitable may be true, but it may also be false. Easing monetary policy in 2008 might well have avoided the crisis. The subprime debacle could have been contained if spending had not suddenly been choked off by the Fed’s passive tightening in response to a spike in energy prices throughout the spring and summer of 2008.
JKH, I am in favor of regulations o reduce fraud and other forms of financial misconduct. And I agree that the Fed is not necessarily the agency that should be in charge of administering such regulations.
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David,
When I look at economic history through the eyes of MacKay, Kindleberger, Graeber, and countless others I see an enduring pattern of financial excesses throughout the history of capitalism in which unregulated financial markets have led to speculative bubbles created by irrational exuberance in environments replete with deception and fraud—the kinds of deception and fraud that create situations in which the system can only be sustained by a continual increase in prices as debt increases beyond any possibility of repayment.
In the three posts you have chosen to examine in this series Sumner argues to the effect that we can ignore this history and the need for financial regulation to provide economic stability because if the Fed had targeted NGDP leading up to the Crash of 2008 everything would have been just fine. And in his “The real problem was Nominal” ( http://www.adamsmith.org/wp-content/uploads/2015/02/therealproblemwasnominal1.pdf ) he emphasizes that “having a stable path for NGDP is very conducive to the argument for free market economics” as if, somehow, this is relevant to the validity of his argument. In defense of this line of reasoning he offers abstract arguments with regard to the demand and supply of money combined with a fallacious explanation as to the way in which saving and investment determine the rate of interest and a convoluted presentation of Keynes’s views of how the economic system works that are comparable to the kinds of arguments, explanations, and presentations that have been used since the 1970s to justify deregulation of the financial system.
For me, abstract arguments, mathematical models, and shifting curves on graphs just don’t cut it when it comes to pontificating on how we should have dealt with the kinds of problems we faced leading up to the Crash of 2008 in the absence of a detailed examination of the institutional nature of those problems. By 2005 we were ensconced in a world in which over-the-counter derivatives and shadow banks were unregulated, large investment banks were allowed to regulate themselves, regulatory agencies were understaffed and underfunded, the Fed refused to exercise its responsibility under HOEPA to regulate the mortgage market, and the Treasury used the courts to bar states from enforcing laws against fraud and predatory lending practices in the mortgage markets. ( https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf and )
This led to a situation in which subprime mortgages comprised 20% of mortgage originations, and 70% of those mortgages were hybrid Adjustable-Rate Mortgages (ARMs) that could not be sustained unless they were refinanced within two or three years in a market that would allow the closing costs to be added to the principle of the loan. This meant that those mortgages could not be sustained unless housing prices continued to increase. It also meant that if housing prices stopped increasing the properties underlying those ARMs would be thrown on to the market which most economists would expect to have a negative effect on housing prices which, in turn, would increase the risk of default on all mortgages, not just hybrid subprime ARMs. (http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf?attempt=2 and http://www.rweconomics.com/htm/WDCh10e.htm )
At the same time, mortgage originators were running out of subprime borrowers by 2005 and were in the process of expanding Alt-A mortgages and talking prime borrowers into converting their prime mortgages that they could afford into hybrid ARMs that they could not afford when the rates reset as securitizers were beginning the process of turning—through the magical alchemy of CDOs and CDO^2s—the non-AAA rated MBS tranches they could not sell into AAA securities that they could sell in an environment in which the rating agencies had no legitimate basis on which to rate MBSs let alone CDO^2s. ( https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf )
To make matters worse, there were some $500 trillion worth of derivative contracts outstanding by 2007 that had been created in the absence of any kind of government regulation that would ensured the viability of these contracts, and non-federal debt was at an unprecedented 286% of GDP by 2005. This ratio peaked at 320% of GDP in 2008, and by that time Fannie and Freddie were leveraged to the point that a 1.5% decrease in the value of their assets would have driven them into insolvency and the major investment banks were leveraged to the point that a 2.5% drop in the value of their assets would have driven them into insolvency as well. ( http://www.rweconomics.com/htm/WDCh10e.htm )
How was targeting NGDP supposed to bring this situation to an end in the absence of a massive inflation that would have kept the system going through the elimination of the real value of the debts that had been created? What effect would the Fed’s targeting NGDP, even if it had been successful in achieving its end, have had on the non-federal debt ratio in the absence of a massive government intervention in this situation, and how would this have helped to stabilize the system?
I would think that one of the clearest lessons of history is that it is impossible for monetary policy to avoid an economic catastrophe in the face of the kinds of financial excesses that inevitably occur when the financial system is allowed to run amuck in the way it was allowed to run amuck leading up to the Crash of 2008, and I don’t see how the Fed could have done anything leading up to 2008 that would have avoided the catastrophe that ensued short of the government having stepped in early to enforce strict loan-to-value ratios for mortgages; placing margin requirements on repurchase agreements; setting capital requirements for hedge funds, investment banks, and SPVs; forcing derivatives onto exchanges with clearing houses when practical, and setting strict reserve and capital requirements when not practical; and strictly enforcing all laws against fraud and other forms of predatory lending practices before the situation got out of hand.
It seems to me that once the financial situation is allowed to get out of hand in the way it was allowed to get out of hand leading up to the Crash of 2008 a crisis is inevitable no matter what the monetary authority chooses to do and that monetary policy is impotent in its ability to stabilize the economic system in the absence of the kinds of regulations on the financial system listed above.
Now when I read the kind of reasoning I see in Sumner’s analysis I not only reject it out of hand as being irrelevant to the kind of world in which we actually live, I see what I consider to be the inevitable results of that kind reasoning to be dangerous. The problem is that when those in charge of our financial institutions are allowed to perpetrate these kinds of reckless and dishonest behaviors as they finance speculative bubbles and increase their leveraged debt beyond any possibility of repayment they not only place their own money and economic wellbeing at risk. They place other peoples’ money and economic wellbeing at risk as well. And to the extent they threaten to bring down the entire economic system they put at risk the wellbeing of all the people who depend on the smooth functioning of the system for their very survival.
The vast majority of the people who are harmed when the bubbles burst and the system collapses are people who had nothing to do with the financial corruption that brought down the system in the first place. They are the millions of innocents who lose their jobs, their homes, their pensions, their life savings, and their hopes and dreams for the future in the wake of the economic catastrophes that follow. This is just plain wrong. It is unfair. It is unjust. And if history tells us anything it’s that people do not tolerate unfairness and injustice of the magnitude that results from this kind of catastrophe quietly unless they are forced to do so through massive repression. ( http://www.rweconomics.com/IVR.htm )
It should not be suppressing that the economic, social, and political upheaval created by the Great Depression following the Crash of 1929 eventually led to World War II or that the fallout from the current economic crisis we are in the midst of today is playing itself out in ways that do not seem to hold much promise for the future.
In my view, no one, but no one, should be allowed to put the economic system at risk for their own personal gain, and most certainly not in the name of some absurd ideological abstractions such as “free market economics.” As Douglas Amy has explained in eloquent detail ( http://governmentisgood.com/ ) there is not, never has been, and never can be any such a thing as a free market. Markets are the creation of governments that set and enforce the rules by which trading takes place. In the absence of a government to set and enforce the rules trading is reduced to the kinds of systems of exchange we see in Afghanistan or Somalia where warring tribes take advantage of every opportunity they can to steal from each other.
Not only are markets the creation of governments, the way in which governments set and enforce the rules by which exchange takes place determines the extent to which the overall outcomes of the exchange in those markets are fair and just. And the failure of the government to set these rules in a way that is fair and just does not lead to economic stability no matter how logically sanguine the abstract arguments of economists may appear to be. It leads to social unrest and civil disorder of the kind we have seen throughout the history of capitalism, and economists ignore this reality at the peril of becoming irrelevant to what is actually happening in the real world. ( http://www.rweconomics.com/IVR.htm )
You are absolutely correct that my “deterministic argument that the crisis was inevitable may be true, but it may also be false.” When I made that argument I actually did ponder the poignant irony of the fact that Sumner and I were both arguing “It might have been!” ( http://www.bartleby.com/102/76.html ) I would also note that your assertion:
“The subprime debacle could have been contained if spending had not suddenly been choked off by the Fed’s passive tightening in response to a spike in energy prices throughout the spring and summer of 2008.”
is also arguing “It might have been!”
None of us can know what would have happened if things had been done differently in attempting to manage the economy leading up to the Crash of 2008 any more that we can know how the lives of Maud and the Judge would have turned out if they had followed their hearts instead of their heads, but just as I choose to believe there could have been a better life for Maud and the Judge, Sumner, you, and I choose to believe there could have been a better way for us to have managed the economy that would have avoided the kind of catastrophe we are in the midst of today.
The fundamental difference between us seems to be that I do not believe the kind of crisis we face today could have been avoided in the absence of strict regulation of the financial system while you and Sumner seem to be unwilling to accept my position as being relevant to the situations we faced leading up to the Crash of 2008.
As I think about this problem I don’t see any reason to believe that the Fed’s not passively tightening in 2008 would have made much of a difference in the absence of an even greater government intervention to bail out the system than we actually saw in 2008 through 2009. As I attempt to explain in Where Did All The Money Go? ( http://www.amazon.com/dp/B00N9H75NG/ref=rdr_kindle_ext_tmb ),
and summarize in http://www.rweconomics.com/LTLGAD.htm , the fundamental problem we faced in 2008, as I see it, arose from the fact that the deregulation of the financial system that began in the 1970s and reached its apex in the 2000s made it possible for the trade deficit and the concentration of income to increase to the point that it was impossible for the system to maintain full employment in the absence of a continual increase in debt relative to income.
This kind of situation is unsustainable, and by the time we reached 2008 non-federal debt had grown so large relative to the rest of the economy and the fragility of the financial system was so great as a result of the unregulated recklessness, fraud, dishonesty, and incompetence of those in charge of our financial institutions that I find it impossible even to imagine any kind of simple solution that—in the absence of a massive governmental intervention in the economic system—would have made it possible for us to have avoided the catastrophe that I see as being the inevitable consequence of the deregulation of the financial system that began in the 1970s. ( http://www.rweconomics.com/htm/WDCh10e.htm , http://www.rweconomics.com/LTLGAD.htm , and http://www.amazon.com/dp/B00N9H75NG/ref=rdr_kindle_ext_tmb )
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