"Important Ideas Have Been Discovered—or, Rather, Rediscovered"

John Cassidy:

Where Is the New Keynes?, by John Cassidy: On Monday, I was on Leonard Lopate’s WNYC radio show talking about my recent article on John Maynard Keynes. (The piece is no longer behind a firewall. You can read it here, and listen to the interview here.) At the end of the show, Leonard asked me an interesting question: Has the financial crisis and Great Recession produced any big new economic ideas? ...

Certainly, there is no new Keynes. But I do think that some important ideas have been discovered—or, rather, rediscovered. Here are six of them...:

1. Finance matters. This lesson might seem obvious to the man in the street, but many economists somehow managed to forget it. ...

2. Credit busts are different from ordinary recessions. ...

3. Positive feedback and multiple equilibria have to be taken seriously. With the rise of rational expectations theory, the idea that financial markets and entire economies can spiral into bad outcomes—and for no very good reason—was relegated to a mathematical curiosity: so called “sunspots.” Now, the notion is back, and for good reason. It appears to describe the world pretty well. ...

4. Especially in financial markets, self-regarding rational behavior isn’t necessarily socially optimal. ...

5. Monetary policy doesn’t always work very well. This lesson should have been relearned in Japan. One person who did relearn it was Paul Krugman. ...

6. Fiscal stimulus programs don’t provide a panacea for deep recessions, but the alternatives—do-nothing policies or austerity—are much worse. If you doubt this, I would suggest you look at what is happening in Greece and the United Kingdom, where austerity programs have been in effect for more than a year. As for the Obama stimulus, most serious studies show it did have a positive impact on G.D.P. growth and job creation—as detailed in this helpful post by Dylan Matthews...

Looking at this list, anyone familiar with Keynes will quickly realize that almost all of the points on it can be found in his writings, at least in embryo form. ...

I'll add one more: Before the crisis Alan Greenspan assured us that there wasn't a housing bubble, and even if there was, and it popped, the Fed could contain its effects and clean up afterward. Nothing to worry about. That was wrong.

That points to one more: The Fed needs better ways to identify bubbles. Because of the belief that bubbles could be contained and easily mopped up, little effort was made to find ways to identify bubbles as they were inflating. Now that we know how much damage bubbles can do -- something we should have known already -- we need to put effort into finding reliable indications of bubbles, and then take action to stop them from doing severe damage.

Another: In this type of recession, saving banks is not enough to restore the economy. It's critical to help households too.