The Theoretical Debate on the Great Crisis

MORO, BENIAMINO

2016-01-01

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Abstract

According to Krugman, the central cause of the profession’s failure to forecast the current Great Crisis is the abandoning of Keynesian theory to explain crises and depressions, and the prevailing of monetarism and neoclassical vision that whatever happens in a market economy must be right. According to Neoclassicals, instead, economic models do not just fail to predict the timing of financial crises, they say that we cannot. This common sense is the heart of rational expectations models. So the correct conclusion should be that our inability to predict the crisis confirms Neoclassical theories. Keynesians suggest that deficit spending is the right policy to put the economic system in a full employment equilibrium path, while Neoclassicals think that fiscal stimulus is only a bad way to transfer money from taxpayers to inefficient bureaucrats, policymakers, and zombie firms. Anyway, Keynesians and Neoclassicals share the opinion that we need a more tightening regulation of financial markets. Commercial banks, who are allowed to manage systemic contracts like bank deposits, and for that reason they have access to the lender of last resort, should be kept strictly separated from investment banks, hedge funds and other financial speculative institutions, none of which should be considered too big to fail. This is the most important convergence between the two schools of thought.