Belfast Telegraph

Friday 25 July 2014

Confusion over who is to blame for the economic crash

Alan Greenspan, former US Federal Reserve chief

Former chairman of the US Federal Reserve Alan Green-span liked to study economic data in his bath. From which we can reasonably conclude that he is different from most of us.

That might explain one of his odder comments about the crash: to the effect that he presumed rational bankers would not wreck their own businesses.

As a result, he saw little need for the Fed to tell them, via detailed regulation, how to go about managing those businesses.

Mr Greenspan's comment, as he very well knows, raises an argument that has been at the heart of economics for at least 80 years and maybe - depending how you look at it - from the very beginning of modern economic thought.

Take, for instance, the description by TCD professor Antoin Murphy, in his book The Genesis of Macroeconomics, of the argument between Richard Cantillon, born in Kerry in the 1680s, and the much-better known Scot, Adam Smith.

"Cantillon recognised that there was a person, the entrepreneur, to initiate and develop the market mechanism," writes Dr Murphy.

"Smith, on the other hand, was content to consider that the whole process was worked out in some invisible manner by the competitive forces of the market."

From the 1970s especially, Smith's "invisible hand" became the dominant idea in economic thought.

Mr Greenspan was a firm believer, hence his inaction as a regulator and his puzzlement that the bankers did, in fact, wreck their own businesses.

It is not just that entrepreneurs, executives and their customers create and develop the market, as Cantillon said.

It appears that, from time to time, they also behave in what seems an irrational manner, so that the market misallocates resources rather than allocating them efficiently - perhaps on a grand scale.

The school to which Mr Greenspan belongs argues that, not only do people act rationally, but that their rational actions will produce the best possible result. The hand is not only invisible, but benevolent.

The alternative view is that, in certain circumstances, what seems to be rational behaviour to participants at the time can lead to very unfortunate results. It all depends on the conditions.

Economists are beavering away to find ways to put more of the vagaries of actual human behaviour into their modelling.

It may be some time yet before they can include the vagaries of national characteristics.

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