Why we couldn't predict or understand the GFC
Wednesday, 4 March 2015
It has been known for some time that monetary theory (an economic model) used prior to the global financial crisis (GFC) of 2007-2008 was seriously flawed; however, a University of Adelaide economist has recently explained just why it failed and what might be a better approach to prevent future financial crises.
Associate Professor Colin Rogers has been researching monetary theory for 30 years and his latest findings were recently published in the European Journal of Economics and Economic Policies.
Associate Professor Rogers, from the University of Adelaide’s School of Economics, says one of the fundamental issues with monetary theory is that it allows maths to preclude some basic economic principles.
“The model used by economists and some governments all over the world to analyse the performance of a country’s economy prior to the GFC was a moneyless model. Monetary theorists either ignored or didn’t understand why money was not needed in the model and persistently tried to find ways to insert money into various versions of the model. This resulted in disastrous consequences,” Associate Professor Rogers says.
“As a result of this confusion, money was incorrectly converted from something that facilitates trade and production into something that constrains trade and production.”
“The mistaken belief that this moneyless model would provide sound theoretical foundations for efficient financial markets also led to reckless deregulation of those same markets around the globe. This created the conditions that produced the GFC,” he says.
Associate Professor Rogers says one of the reasons Australia came out of the GFC fairly unscathed was because the Australian Government joined the effort to stimulate the global economy rather than cut spending.
“As it has been clearly demonstrated around the globe, particularly in Europe, that raising taxes and cutting government spending in a recession causes the economy to contract further. And tax increases and cuts to government spending may also fail to stabilise the
national debt, as is the case in Greece,” he says.
“Instead of imposing austerity in a recession or on a slowing economy, governments should allow the old built-in stabilisers to work through the tax and transfer systems. For example, if there is a problem with the structural budget balance, a boom is the time to fix it, not a
“The stimulus package rolled out around the world and by the Australian Government really was what saved us from a recession after the GFC,” he says.
Associate Professor Rogers says the past should be kept in mind when drawing up this year’s budget.
“With the Australian economy now slowing it would be unwise to cut the deficit too hard in the forthcoming budget,” he says.
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