Raghuram Rajan: True Lessons of the Recession

Modeled Behavior links to Raghuram Rajan's The True Lessons of the Recession (12-page PDF). Rajan's opening surprised me:

According to the conventional interpretation of the global economic recession, growth has ground to a halt in the West because demand has collapsed, a casualty of the massive amount of debt accumulated before the crisis.

Yes, exactly. But that's the conventional interpretation? I wouldn't have thought so.

The rest of Rajan's opening paragraph does sound more like the "conventional" story. Some of it sounds like what the Fed is doing:

Households and countries are not spending because they can’t borrow the funds to do so, and the best way to revive growth, the argument goes, is to find ways to get the money flowing again.

The rest of it sounds like what Paul Krugman is saying:

Governments that still can should run up even larger deficits, and central banks should push interest rates even lower to encourage thrifty households to buy rather than save. Leaders should worry about the accumulated debt later, once their economies have picked up again.

Myself, I don't see how the first sentence has anything to do with the rest. We boldly admit there is too much debt everywhere we turn. So the obvious solution is to reduce that debt. But nobody ever gets to that conclusion!

Instead, we want to "get the money flowing again". I think that means: get everybody borrowing more again. Does that make sense, when the problem is that there is too much debt?

Getting governments to "run up even larger deficits" is the opening salvo of the solution that wants everyone to run up even larger debts. And promising to worry about that debt later, well, that's plain hypocrisy. Can't fix the roof when it's raining, don't need to fix it when it's not.

... growth has ground to a halt in the West because demand has collapsed, a casualty of the massive amount of debt accumulated before the crisis.

Yes, everyone has said at one time or another that the massive accumulation of debt was the cause of our troubles. Then they move on to other things, all of 'em.

Rajan himself some two years before the crisis, according to the Wall St. Journal (2 January 2009) in August 2005 "chose that moment to deliver a paper called 'Has Financial Development Made the World Riskier?'"

"His answer: Yes", the article reports.

Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. Rajan argued. That encouraged financial firms to invest in complex products with potentially big payoffs, which could on occasion fail spectacularly.

He pointed to "credit-default swaps," which act as insurance against bond defaults. He said insurers and others were generating big returns selling these swaps with the appearance of taking on little risk, even though the pain could be immense if defaults actually occurred.

Mr. Rajan also argued that because banks were holding a portion of the credit securities they created on their books, if those securities ran into trouble, the banking system itself would be at risk. Banks would lose confidence in one another, he said: "The interbank market could freeze up, and one could well have a full-blown financial crisis."

Two years later, that's essentially what happened.

So Raghuram Rajan himself has been among those pointing a passing finger of blame at finance, at our massive accumulation of debt. But now that is just a "conventional interpretation" that he rejects.

Today, Rajan's plan for the US consists of

educating or retraining the workers who are falling behind, encouraging entrepreneurship and innovation, and harnessing the power of the financial sector to do good while preventing it from going off track.

Education, deregulation, and finance, Rajan says. More and better finance.

More and better excessive debt? Really?


I assume Rajan still thinks excessive debt caused the crisis, caused the sudden collapse in demand. So why he doesn't go immediately to the conclusion that the solution is to reduce debt, mostly private debt, I do not know. But like everyone else, he does not.

Perhaps he is considering the "prospects for growth ahead", as the Grumpy Economist said. Perhaps Rajan remembers that the economy was not so good even before the crisis, and he is looking ahead, looking to fix that problem. To fix the problem we had when things were still "normal", before everything fell apart.

Okay. So then the problem is solved for Rajan by education and deregulation and expansion of finance; and the "massive amount of debt accumulated before the crisis" was just an anomaly and the crisis a one-time thing, an accident.

Except, how do you expand finance without increasing the accumulation of debt? I don't think you could do it, even if you were heavy-handed with regulation, like Haldane. Regulation is ineffective. The profit motive is an irresistible force. Regulation is not an immovable object.


Education is not a bad idea. If we live in a world where machines make everything, so that jobs are not plentiful, in that world we have to do something to make money, and we have to do something to spend money. Education fills the bill nicely: we can be teachers and students.

If you just limit your education to things that interest you, there's still so much available that there need be no end to it, and we can keep each other employed forever, basically, with a low requirement for natural resource use besides. And, to be known throughout the universe as an education-based society is not the worst thing that could happen.

So I like the education idea. But I still have a problem with Raghuram Rajan's analysis. Based on what I think he must hold true:
1. He knows the economy was not doing well even before the crisis.
2. He knows that the crisis was caused by excessive debt or "finance".
3. But by some magic, he seems to think that excessive debt is not really the problem, and that we can expand finance again as soon as we get out of the doldrums. Obviously, he is a man who has never contemplated the Debt-per-Dollar graph.

Has he never considered that the persistence and gradual worsening of our economic troubles is in any way related to persistent increase in debt? There were problems before the crisis, and then there was the crisis. And the crisis was brought on by excessive debt, excessive finance. At least that is what Rajan said some two years before the crisis.

But somehow, Rajan does not seem to see any connection between our growing debt and the problems we had before the crisis. For him it is as if the crisis was anomaly, the excessive debt as a problem was anomaly, and the anomaly soon vanished. This is the emptiest of arguments.

My god, man, the debt has been a problem since the 1960s. Think of it in those terms, analyze it in those terms. It explains everything.