What Have we Learned From the Financial Crisis? Part 3: Mario Seccareccia

What follows are comments from a roundtable discussion held at the University of Ottawa on February 28, organized by Mario Seccareccia, and which featured participation from Marc Lavoie, Louis-Philippe Rochon, Mario Seccareccia, Slim Thabet and Bernard Vallageas.

This is Part 3 of 5 sequential blog entries.

Mario Seccareccia
Professor of Economics, University of Ottawa
Editor, International Journal of Political Economy

I would like to argue that policy makers perhaps learned very little, especially in light of the fact that they have recently acted out the same macroeconomic policy script that was written in the 1930s. However, before discussing what they did, I would like to offer a brief analysis of the experience of the 1930s and that of the current Great Recession.

While there are obvious similarities between the Great Depression of the 1930s and the current Great Recession, the latter has not degenerated into a serious deflationary episode characterized by rising real interest rates, rising real indebtedness and a dangerous deflationary dynamic of falling money wages and prices. Interestingly both crises have their roots in problems of rising inequality and bubbles in asset markets. The recent collapse, beginning in 2007 with the subprime crisis, was triggered by problems in the housing market, which was then transmitted to the banking and financial markets in 2008 and eventually to the real economy by 2009. During the Great Depression, the sequence was somewhat in reverse, with problems beginning in the stock market, which then led to the collapse of the banking sector and then had obvious ramifications in the real economy, including the housing market. Despite some similarities with each recession being preceded by some type of financial crises, by any measure the Great Depression was more severe than the Great Recession. 

From its peak in 1929 to the trough in 1933, real GDP and employment fell by 30 percent or more in both Canada and the United States. At the same time, real wages rose consistently, initially because prices fell more than wages until 1933, and then because nominal wages began to rise more than prices after 1933. Despite the sharp fall in employment, the reverse movement of real wages served to redistribute purchasing power in such a way as to offset the overall decline in aggregate demand. This was further reinforced by a fall in the personal savings rate until 1933 as households initially sought to maintain their previous consumption norms, despite their fall in nominal income. However, once nominal income and employment began to turn around, the saving rate began to rise after 1933, as households sought to reduce their debt load.

During the Great Recession, the situation was similar in terms of negative fluctuations in output and employment, but these data series displayed only a very mild decline in output and employment after 2007-2008. Indeed in the US, output and employment fell close to 3 and 6 percent respectively, with Canada showing some limited decline in the two series of about 3 percent only during 2009. The collapse in aggregate demand triggered a disinflation in prices but without making any significant dent on money wage growth that continued its inertial slow growth pattern established during the preceding “great moderation”. Hence, unlike the 1930s, real wages continued to rise, but, in this case, because money wages outpaced prices after 2007-2008. There was no massive deflation as during the 1930s. On the other hand, unlike during the Great Depression when the savings rate initially fell, households were so heavily burdened with debt during the recent downturn that, in the face of uncertainty, they quickly raised their saving rate in order to remove some debt off their balance sheets, thereby exacerbating the problem of aggregate demand.

Did policy makers understand the realities of the two economic crises and were the macroeconomic policies that they implemented appropriate for the times? An analysis of the experience of the 1930s would suggest that we repeated some of the same mistakes during the present crisis. In both Canada and the US, the conduct of monetary policy during the Great Depression was not unlike the pursuit of monetary policy during recent years.  The reaction during the 1930s on the part of the US Fed was to pursue an easy money policy of setting nominal interest rates at their lowest possible levels. In Canada, the Bank of Canada only began its operations in 1935. However, prior to 1935 and since the Finance Act of 1914, discount rate policy was under the control of the Minister of Finance.  In all cases, the monetary authorities desperately sought to reduce nominal interest rates to very low levels, despite the fact that prices were falling until 1933, which meant that real interest rates were rising until the mid-1930s. This also meant that income was actually being redistributed towards rentiers, thereby somewhat aggravating the Keynesian problem of effective demand. During the recent crisis, the reaction of the monetary authorities was swift, not only in bailing out the banks (as in the US) or providing loan guarantees for the banks (as in Canada); but, more importantly, central banks immediately cut interest rates to their lowest possible levels and pegged them at those low levels. Moreover, with nominal interest rates pegged at their low nominal levels and with an inflation rate that remained positive, real interest rates actually turned negative. While, according to conventional wisdom, this (as well as so-called quantitative easing) provided a stronger monetary stimulus than in the 1930s, this was insufficient seriously to kick-start the recovery. Hence, it was recognized, as in the 1930s, that low interest-rate pegging was an insufficient tool to achieve growth. That was true then as it has been true over the last half decade.

On the fiscal side, it took some time for the fiscal authorities to react with expansionary fiscal measures. Both Herbert Hoover in the US and R.B. Bennett in Canada were seeking to combat the expanding deficit as tax revenues fell and public spending automatically rose after the 1929 collapse. However, by 1932 in Canada, things did begin to change as there was a greater recognition of the need to implement some public works program. In the case of the US, with the defeat of Hoover in 1932 and the coming of Franklin Roosevelt in 1933, there was the ushering of a package of policies commonly referred to as the New Deal that led to significant growth until 1936. With “green shoots” appearing, the fiscal authorities began to move in reverse gear that caused a double dip recession by 1937, thereby guaranteeing stagnation until the Second World War. In the case of the Great Recession, the fiscal authorities were quick to adopt fiscal stimulus packages with significant deficit spending from the end of 2008 to early in 2010. However, as in the 1930s, once the “green shoots” started to appear, most Western governments began to reverse their policies by instituting austerity, thus aborting a significant recovery.

What can be seen from this cursory history is that the package of macroeconomic policies was similar in both periods first through deep cuts in interest rates, and then followed by some fiscal stimulus. However, in each of these historical periods, the fiscal authorities pursued policies that would eventually mitigate growth and ensure long-term stagnation.  The only difference between the 1930s and the current period is that this was repeated and expedited during a shorter period; but the consequence in terms of long-term stagnation is not dissimilar.  Hence, it can be said that policy makers either learned little, by prematurely withdrawing the fiscal stimulus, or it may be argued, à la Kalecki, that they knew the consequences, but they desired this outcome because the balance of political forces at work were not much different during those two eras: with fears of “unsustainable debt” and the need to ensure the “confidence” of the financial markets being a common theme for both historical periods.


  • I think the only way economists can change the sorry state of their profession is to attack it for not remotely resembling a science. Fact is so-called economists are pushing political and social agendas. They should be exposed.

    Long ago scientists and doctors shaped up their fields by mercilessly attacking charlatans and quacks. That’s what economists must do. They must make it their goal to turn economics into a rigorous science.

    Take the Rogoff Reinhart paper on government debt that cooked statistics to push a destructive political agenda. If that had occurred in science, journalism or any credible academic field, they would be flipping burgers now. But instead they are getting published as if nothing happened.

    Until economists take their own field seriously, no one else will. No one else should.

  • Mario Seccareccia

    I certainly agree that we should mercilessly attack those economists who do science fiction by developing models of the world that pretend to simplify reality while, in actual fact, distorting it, and then framing policies on the basis of that distorted description of reality. However, despite the pretension of most mainstream economists and unlike medicine and just like other social sciences, economics cannot be ideology free as one finds somewhat in the natural sciences, since economists are human beings who hold certain world views from which they cannot detach themselves and which often drives their personal research agenda. The best that one can do is to expose this “quackery” (as you describe it), to assert that it’s not value-free, and to offer alternative perspectives by shattering the Maggie Thatcher outlook that there is no alternative (TINA) out there. Indeed, in economics, there is always an alternative and that is why we constituted the PEF!

  • I’ll definitely have to keep an eye out for what you’re doing here on the PEF. Now I follow Economist’s View and Paul Krugman.

    But I have to wonder if some economic hypotheses can be proven or disproven.

    Take, for example, human origins (as a scientific example.) One schools posits the out-of-Africa explanation; the other multiregional. Scientists keeping pinning down facts that support or contradict one theory over the other. The debate is not over, but a lot of progress has been made because the facts can’t be denied.

    As Paul Krugman points out, in macroeconomics there are many “zombie” hypotheses: theories that the evidence should’ve killed but they keep shambling on in any case (because of political agendas.)

    Now take fiscal measures in a slump. We have a lot of evidence to suggest austerity is self-defeating (among other things.) So can’t something be pinned down to some degree of scientific certainty?

    If economists could start pinning down facts, then real progress could be made on what economic polices work and which ones do not. Perhaps economists should consult scientists for ideas.

    Science is always open to new hypothesis and theories. The theory of evolution was recently turned on its head when it was discovered that many kinds of bacteria swap DNA, which challenged the long held assumption that evolution happened via a tree of life.

    So with more scientific rigor, alternative theories could have a better chance of making a breakthrough (like Special Relativity) than having to rely on arbitrary political support (which can support destructive theories just as easily.)

    I think that if economics is not made into a science we will keep running in circles until inevitable economic chaos turns to political chaos and the destruction of civilization.

  • Unlike other sciences, in macroeconomics it is very difficult to do a double blind study on the effects of a policy on 50-100 similar countries to get a statistically sigificant result.

    Of course, that doesn’t mean the data is available shouldn”t be used. How do these neo-liberal economists explain World War II?

  • “the recent collapse, beginning in 2007 with the subprime crisis, was triggered by problems in the housing market, which was then transmitted to the banking and financial markets in 2008 and eventually to the real economy by 2009.”

    I am not sure I can throw my hat in on this- I think it is a correct causal but missing some root causation, that may or may no be concurrent causation, many linkages between them- but I do think this whole crisis in deed started with the financialization-call it stock markets if you want. But the whole shadow banking system had a massive part in how this played out and was part of the root causation. The growth of derivatives in many of its vehicles, equity, forex, interest rate swaps, credit default swaps, futures trading in commodities and some of the other more exotics that are still nameless- all were growing in massive scale and scope. They once served as lubricants- as Marx depicted in Volume 2 on finance capital and the circuitry need for investment. However, when finance escapes the parameters of the entire system of capital and start treating money as its own commodity to control its growth outside of the circuits- that is a major problem and as David Harvey argues- plugs the system. Not only did it plug the system but it started creating even more demand outside of its own space to pull in securitization of such things as mortgages and such to be a part of the process in an even more arcane and risk centric manner- apparently risk of the particular ignored risk of the entire system- as that is indeed what controls the entry into this entire shadow banking chaos- the notion that risk had been defeated in the micro meant opening the doorway to leverage ratios that made the entire system more risky- so in many ways it created a recursion into the mortgages markets.

    The second part of the story in terms of causation is the whole equality equation which again considering Volume 2 hits upon the circuitry of worker wages and the grand notion of declining demand of workers. Why? Well I think a lot had to do with profit formation in the finance circuitry were becoming replacement profits, essentially western countries finance of the JP Morgans and Goldman Sachs etc, thinking it did not require productive capital profits to the same degree and there fore was content and designing a new base within the superstructure to park much of its “risk free assets”. So this again plugs up the circuits by deceasing the velocity of wage demands back to workers, and essentially the sustainability of surplus exaction.

    (Also I would point out here that technology although a major productive force also carried with it massive levels of risk- tech change and roll over was no longer the safe bet it was in terms of production process and value chain profitability- i.e. constant capital- in marxian terms suddenly had a depreciation that was no longer risk free- you cannot just introduce a system and expect a 20 year straightline depreciation – steel is steel of the analogue age, but web tech is web tech in the age of digital. This does have some massive impacts on where an immature massive tech that has great potential but can be risky to embed into the centrality of a massive production system- I still feel flexible specialization production theory was just code for we wanna innovate and bring in smart automation but it is changing so fast and it is costly- hence the dawn of big data- smart automation version 2.0.)

    And lastly we do have to consider the last of the circuits of distributive capital- i.e. what Marx called merchant capital. A massive capital flight over the past 30 some years productive capital to low wage regions of the world. The impact on profits on this transformation are actually positive in the shorter term but again plug up the system because of the wage reduction and demand implications in the productive sphere. On the plus side for capital- through ingenious marketing of cultural control- merchant capital of the west was able to continue to extract production based profits through value chain enhancements and boundary of the firm redefinitions of suppliers. Essentially, capital no longer produces the produce in its national markets but extracts the profit from production through control of product through 1) branding and 2) monopoly over distribution. So tranforming the value adding process through affixing a logo to a shoe can bring more value (many times over) to a product than actually producing it- (Marx would have loved that one).

    So to me one has to consider where did the causation come from- was it the housing markets? Partially but that to me is only a part of a larger and much complicated story that goes back to Marx and the chapter 1 of capital- what is a commodity – use value and exchange value- and how profits are made. The starting point for me to fix this is a global response to finance- capital controls, regulating the vehicles of finance through policy and taxes on transaction- also a cultural response is needed- to show just how wrong such transformations in the concretization process of what value is and how profit is made.

    Just a few points that I have been waiting for an opportunity to get out of my head- sorry for the length Mario- maybe this was that coffee you and I were supposed to have- virtually I guess- ;).

    Take care- and I apologize for any mistakes above in my intepretation of Marx and what is going on. I have been listening quite a bit to David Harvey and reading Vol 1 and 2. I think technology and innovation has a whole host of research and understanding that is needed- also those damn financial markets are totally out of control- now the finance sector is printing their own cash without any state saying much- especially the biggest one the USA- why- because of a lack of a global presence to stop it- so in game theoretic terms the optimal outcome is to let your finance sector print money- as everybody else is- was it QE 1 that signaled it, the massive growth in China that solidified it, the Euro response to its crisis that sold it and it was abeconomics that sealed our fate on this pathway of printing money- it is indeed a weird kind of privatized fiscal monetary policy- but I would prefer to see some of that money actually go into the public sector! lol- and lastly maybe a green Keynesian-ism would not be asking for too much given the crisis of the planet!

    And by the way everybody says Canada

  • sorry I mean to say everybody seems to think Canada danced through the tulips (hopefully spring will come with mention of tulips) in terms of avoiding a housing crash. Indeed we have managed- but given we are at the lowest level of public spending at the federal level- and somehow that stuff needs to get paid for- we are now at the highest level of indebtedness ever- so really how is it we avoided any major recession- we had to all put it on our personal credit to fire our way through the storm of the great recession. And Harper made it much worse with austerity- all to do with his quest to make government small. On a contradictory note- he did provide the banks a massive mortgage guarantees through CMHC which again allowed Canadian banks to securitize those mortgages and get involved in the shadow banking free for all- much of which as you know is off balance sheet so who knows how much is really out there swirling in what the International Bank of Settlements estimates at $640 trillion dollars in derivative vehicles. Add on to that the corporate cash that many say is sitting in piles of dead money- it would be ludicrous to think that Canadian corporation would be sitting around with a half a trillion sitting in bank accounts- they would not be in business long- that dead money is tied up in the shadow banking sector- I still do not understand why the left keeps insisting on half the story- I know it may seem to make great headlines- but I do think we are letting the corporations off easy – recall me note above on cultural change needed on profits and value are constructed in the public space!

  • Mario Seccareccia

    This is a very quick reply to the comments especially from Ron and Paul. In the case of Ron, I certainly believe that we can “disprove” theories. The problem is whether the mainstream profession will accept the proof. For instance, Keynes’s celebrated analysis and, indeed, any meaningful empirical analysis of the Great Depression during the decade of the 1930s would suggest that the private economy derailed and got stuck in a high unemployment state without any tendency towards full employment. In my humble opinion, this empirical fact does “disprove” the theory that the economy would “tend” towards full employment. Yet, after WWII, economists began to question Keynes’s analysis by arguing that the adjustment was just too “slow” because of wage rigidity (thereby leaving the economy in a “disequilibrium state”), and then this was followed by Friedman and the natural rate and then the NAIRU, whereby neoclassical economists simply redefined full employment as being that “equilibrium” level of unemployment that the economy grinds out when there are no inflationary pressures, thereby suggesting that the private economy gravitates around the natural rate of unemployment unless the government seeks to pursue interventionist monetary/fiscal policies that are either inflationary or deflationary. Such an intellectual sleight-of-hand is a good example of how, regardless of how one discredits a theory, as long as the ideological basis for that view exists, it will survive and come back in some other hybrid form.

    As to Paul’s comments, I must say that I do not much disagree with his main point about financialisation as an underlying cause, especially with securitization à outrance, etc. (if anyone is interested, I published a paper on exactly that question in the Winter 2012-13 issue of the Journal of Post Keynesian Economics where I analysed what happened in Canada before and during the financial crisis). However, what I was referring to in my intervention at the roundtable (in my PEF blog piece above above) was that the PROXIMATE cause was the subprime crisis of 2007 that had to do with the collapse of the housing market and not the stock market on Wall Street as in 1929. Hence I was merely highlighting, in a superficial way perhaps, the simple sequence of events. However, I must say that I do feel a bit uncomfortable with the use of such neologisms as financialization, etc., because they lead sometimes to merely throwing around buzzwords that actually mean different things to different people and ultimately offer little substantive explanatory value. Perhaps readers would like to take note of the special winter 2013-14 issue of the International Journal of Political Economy where this whole question of financialisation is debated among a good number of prominent heterodox economists. Unfortunately, this special issue is not yet out, but it will be so shortly. For anyone interested in the table of contents, here it is:

    IJPE, Vol. 42, no. 4 (Winter 2013-14)
    Special Issue: “Understanding Financialization: History, Theory and Institutional Analysis”

    Editor’s Introduction

    “What Is Financialization?”
    Malcolm Sawyer (University of Leeds, Leeds, UK)

    “Financialization in a Long-Run Perspective: An Evolutionary Approach”
    by Alessandro Vercelli (University of Siena, Siena, Italy)

    “Financialization from a Marxist Perspective”
    by Ben Fine (SOAS, University of London, London, UK)

    “Critical Observations on Financialization and Financial Process”
    by Jo Michell (University of the West of England, Bristol, UK) and Jan Toporowski (SOAS, University of London, London, UK)

    “Financialisation in Developing and Emerging Countries: A Survey”
    by Bruno Bonizzi (SOAS, University of London, London, UK)

    “Financialization and Economic Growth in Developing Countries: The Case of the Mexican Economy”
    by Noemi Levy-Orlik (Universidad Nacional Autónoma de México, Mexico City, Mexico)

  • I always marvel at the way “fraud” is never mentioned when describing the causes of the financial crisis in the U.S. There was fraud aplenty: fraud in lending, fraud in securitizing sub-prime mortgages, fraud in rating the mortgages that were securitized, fraud in foreclosures and fraud represented by robo-signing. In short, there was massive accounting control fraud that brought down the banks who were then bailed out and never learned anything about not committing fraud and so the fraud continues on.

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