In a recent FT article, Claire Jones reported on the decision by Manchester University to reject a proposal for a course on ‘Panics and bubbles’, the initiative of the Manchester students’ pressure group ‘Post Crash Economics‘ and sympathetic academics.
On the limited evidence of the course reading list, I thought that the course missed a great deal. I also thought that Claire’s article was a bit one-sided, implying that the decision to ditch the course illustrated the continued, ostrich-like stupidity of the economics profession.
Claire’s article invoked two wise spirits in favour of the Manchester course. One was Wendy Carlin, who has led an Economic and Social Research Council-funded effort to overhaul the teaching of macroeconomics. But Wendy’s (excellent effort) doesn’t urge binning the macroeconomics canon in favour of Austrian or informal analysis [as the PCE lot seem to advocate]. It’s centrepiece is to try to get the New Keynesian model used by central banks to be the focus of the undergraduate macro canon, rather than the older IS/LM model, harder to relate to contemporary debates (without the obduracy and genius of Paul Krugman). This is decidedly mainstream (and welcome).
The other spirit invoked by Claire was Andy Haldane, outgoing Executive Director for financial stability at the Bank of England. Claire quotes Andy as saying, in support of the PCE’s manifesto: “The economy in crisis behaved more like slime descending a warehouse wall than Newton’s pendulum, its motion more organic than harmonic.” Two points. Take a look at Andy’s cv of papers and speeches, and you find them peppered with formal, mathematical, decidedly mainstream work, or references to them [more on this later]. Second, this metaphor from Andy could rather be taken to be a call to get more mathematical (and therefore ‘mainstream’), not less. The inference is that the crisis is like a fluid dynamics problem [comment stolen from friend who has to remain nameless]. The study of fluid dynamics is built from heavy-duty applied mathematics [more so than frontier economics, perhaps]. Students wanting to draw the analogy between the financial crash and organic processes had better stop chatting about Austrian economics and start crunching exotic nonlinear ordinary differential equations [or rather, starting the slow and painful process of learning how to do it]. Even if heterodoxy is to be the new orthodoxy, students are going to need suffer the trials of dynamic mathematics.
Looking through the reading list for the PCE Manchester course, and presuming that this list sketches its scope, it seemed to miss the grand flowering of mainstream financial macro and microeconomics. If I were teaching a course on panics and bubbles, I would try to give a guided tour of it. For example…
- I would take them through Diamond and Dybvig’s classic model of banks runs, how redeeming deposits on a first come first served basis causes runs on even healthy banks. And I would take them through the analyses of moral hazard in the provision of public deposit insurance to stop these runs [for example, see the references in Sargent's LSE lecture, or indeed Andy Haldane's speeches].
- I would discuss with them Geanakoplos’ work on how leverage and bouts of optimism creates booms and busts in asset prices.
- I would devote time to discussing rational expectations, monetary, overlapping generations models of fiat money, in which one can see that money acts like a ‘bubble’, and which serve to explain in the purest sense what a bubble can mean, of the kind recounted in the famous conference volume edited by Karaken and Wallace.
- I would try to give a taste of the work of Angelotos and co-authors, Morris and Shin and Shleifer and Vishny who have sought to model how beliefs (eg about the value of an asset, or the likelihood of a future event) can spread and become self-fulfilling. And I would talk about the foundational work too of Roger Farmer and co-authors establishing the macroeconomics of self-fulfilling prophecies in rational expectations models; these insights showed how pure shocks to expectations [like waking up and feeling pessimistic for no reason] can cause business cycles.
- I would give some time over to explaining the work of Hansen, Sargent, Cogley, Colacito, Ellison and other collaborators who have shown how asset prices can rise and fall as investors, doubtful of their own models of the dividends from holding an asset, revise their forecasts, and adjust their portfolios to prepare themselves for the worst. [And, using similar techniques, how monetary policymakers may have aggravated booms and bust, weighing up the signals from competing models of the economy].
- I would make students read the literature on learning in macroeconomics, from its origins in Bray and Savin [and earlier], Marcet and Sargent, through to more recent applications by Adam and Marcet, who showed how cycles in share or house prices can be induced by learning agents revising forecasts of the value of the assets they hold.
- I would try to introduce the economics of networks; related modern models of money whose value comes about as a way to economise on search for exchange partners, and which give one clear insight into the meaning of ‘liquidity’, (and thus into how liquidity can appear and disappear).
And having done all that, I would regret that there wasn’t time to devote a whole degree to the topic, and I would stuff the reading list with reams of papers I hadn’t even properly read myself, perhaps sentimentally hoping to entice a student to come back for more in postgraduate study. I’d list Brunnermeir and Sannikov’s work [A survey by the former did make the reading list, as Claire Jones pointed out to me]; I’d tantalise them with the Clarendon lectures of Shin, and John Moore. I’d offer the collected works of the Kiyotaki-Moore collaboration. I’d retrospectively regret that I hadn’t had time to lay out standard models of macro-finance and their failures, set out in the sequence of papers by Lucas, Svensson, Mehra and Prescott, Campbell and Cochrane, Epstein and Zin, Fama, Shiller and many more, and, not knowing what to do about it, I’d slap them down in the reading list to perplex the students further. And, in the same vein, I’d regret that I hadn’t yet set out the standard ways of including banking and finance in macro [due to Bernanke, Gertler, Gilchrist, Carlsrom, Fuerst, and others], where no bubbles and panics prevail, but one gets insight into how to formalise what finance does, and how it can amplify business cycles. So I would shove all of those into the reading list too, wishing instead that another module could be taught on that. And then, right before signing off and sending it out to the Faculty Committee responsible for approving the course, I’d fret that there was nothing on empirical macro. After all, we might talk about panics and bubbles causing booms and busts, but how have people rolled up their sleeves to figure out what did cause business cycles? And then another alarm bell would go off, worrying that students could hardly be expected to make sense of this without a proper introduction to game theory. And then another, warning that we had not touched on the economics of financial regulation, or its political economy…
I don’t really know why the proposal for the Manchester course on panics and bubbles was rejected. But, if it were me, I would have ditched it too, in favour of a course that looked more like the above.