70s crisis – crisis of Keynes ideas

2008 crisis – crisis of neoclassical ideas

Most important contributions by Keynes:

 Psychology of investing
 Role of supply and demand (demand side model, crises are produced by lack of
demand)
 Distinction btw risk and uncertainty (risk is quantifiable whereas uncertainty is
not)
 Importance of government policies (government intervention, spending)
 Importance of expectations
 Money is not neutral, an increase in money supply has an impact in terms of
the interest rates and the income (increase money supply = lower interest rates
resulting in more investment and more income)
 Morals of economics (the objective should be creating a better world)
 Markets are not efficient to allocate resources, they don’t reach an equilibrium
 Markets can be driven by this “animal instinct” (panic leads to more panic)
optimism and pessimism
 Rejected the existence of a “natural rate of unemployment” (voluntary
unemployment, reservation wage is higher than the equilibrium wage of the
market)
 Level of wages determined by the social conditions (exogeneous)
unemployment comes when the level of demand is low

These ideas were relevant during the 2008 financial crisis:

Use of mathematical models to support that markets were efficient.

Rational individuals consider all the information available, so prices reflect this. Keynes
criticized this because markets are also influenced by the “wisdom of the crowd”.

Keynes disagreed with both schools of economics from USA (freshwater’s(neoclassical)

and saltywater’s (Keynesian)) with the idea of rationality of expectations.
For him expectations are important but not in the sense of anticipating events, but to
analyze the psychology.

(excessive mathematization) he criticized the use of the bell-curve (Gaussian), because

it doesn’t take into account the black swans.

Sub-prime mortgages. “diversification” massive sell of sub-prime mortgages to

eliminate risk.
This is the problem. Wrong assumption of mathematician models.

That’s why government intervention is important.

To overcome 2008 crisis in USA:

 Fiscal stimulus (government spending, packages…)

 Quantitative easing (massively printing money and bringing interest rates to 0)