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Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
Thomas Mayer - The Challenges of Economic  Thinking in Practice
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Thomas Mayer - The Challenges of Economic Thinking in Practice

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Thomas Mayer - The Challenges of Economic Thinking in Practice DB Research

Thomas Mayer - The Challenges of Economic Thinking in Practice DB Research

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  • 1. Deutsche BankDB Research The Challenges of Economic Thinking in Practice Dr. Thomas Mayer, CFA Chief Economist of Deutsche Bank Group tom.mayer@db.com (+49) 69 910 30800 24 January 2012
  • 2. My main points Conventional economics did not anticipate the financial crisis, cannotexplain it, and cannot make recommendations on how to overcome it,because it does not understand the credit cycle. To understand the credit cycle practitioners had to study economichistory and dig up old economic theories long discarded by themainstream. „Rethinking economics“ requires that we shift the focus from„deduction“ (like in natural sciences) to „induction“ (like in social orhistoric sciences) for the development of economic theories.Deutsche Bank Thomas MayerDB Research Chief Economist 1
  • 3. The macroeconomic consequences of conventionaleconomics •Theory of rational expectations •Theory of efficient markets Monetary policy should target inflation Asset prices can be ignored Regulation can be „light“Deutsche Bank Thomas MayerDB Research Chief Economist 2
  • 4. 1. Control illusion "If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.“ Paul Krugman in late 1990sDeutsche Bank Thomas MayerDB Research Chief Economist 3
  • 5. The financial market consequences of conventionaleconomics •Theory of rational expectations •Theory of efficient markets •Probability distribution of financial market prices known (and ideally normal) Modern portfolio theory Value-at-risk LeverageDeutsche Bank Thomas MayerDB Research Chief Economist 4
  • 6. 2. Control illusion “At the beginning of 1998, the firm (Long-Term Capital Management) had equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion, for a debt to equity ratio of over 25 to 1. It had off- balance sheet derivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps.” Source: http://en.wikipedia.org/wiki/Long-Term_Capital_ManagementDeutsche Bank Thomas MayerDB Research Chief Economist 5
  • 7. But: What if these theories do not appropriately describe the behaviour of humans and markets? The (probably) biggest credit bubble of all timesDeutsche Bank Thomas MayerDB Research Chief Economist 6
  • 8. The burst of the credit bubble •US sub-prime credit crisis (early 2007) •Money market crisis (mid-2007) •Banking crisis (2008-09) •Public debt crisis (2009-?) •Euro crisis (2010-?) Next •Monetary crisis?Deutsche Bank Thomas MayerDB Research Chief Economist 7
  • 9. Business cycle theories where credit plays a keyrolePost-Keynesian economics Austrian economics(Minsky) (von Mises, Hayek, Schumpeter)Hedge borrowing Credit expansion phase -Speculative borrowing investment boomPonzi borrowing Credit contraction phase - investment bustDeutsche Bank Thomas MayerDB Research Chief Economist 8
  • 10. Minsky‘s financial instability theory Credit Minsky moment Speculative Ponzi Hedge borrowing borrowing borrowing tDeutsche Bank Thomas MayerDB Research Chief Economist 9
  • 11. Minsky‘s error Financial regulation can help stabilise the economy Fiscal and incomes policies can help stabilise the economy But: Regulation and economic policies have been more often pro- than anticyclicalDeutsche Bank Thomas MayerDB Research Chief Economist 10
  • 12. The Austrian business cycleGDP market rate < market rate > market rate = natural rate natural rate natural rate tDeutsche Bank Thomas MayerDB Research Chief Economist 11
  • 13. The liquidationists‘ error "…liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people." Andrew Mellon, US Secretary of the Treasury, 1921-1932 But: What if rising risk aversion keeps the market rate above the natural rate? Economic policy needs to reopen the credit channelDeutsche Bank Thomas MayerDB Research Chief Economist 12
  • 14. Overcoming the “fear of fear itself“ c ha nge , % of Unite d Sta te s % yoy 15 8 GDP 10 4 5 0 0 -4 -5 Credit impulse, % of GDP -8 -10 Real consumption + investment -12 (rhs) -15 1928 1930 1932 1934 1936 1938 1940 1942 Source : US Fe de ral Re s e rve , DB Global Marke ts Re s e arch Notes: Credit impulse := change in net lending flows from financial to private non- financial sector in % of GDP; Real C+I := real private consumption + investmentDeutsche Bank Thomas MayerDB Research Chief Economist 13
  • 15. The power of credit c ha nge , % of GDP % yoy 12 Unite d Sta te s The goldilocks phase 8 8 4 4 0 0 -4 -8 -4 Credit impulse, % of GDP-12 -8 Real consumption + investment (rhs)-16 -12 1928 1938 1948 1958 1968 1978 1988 1998 2008 Source : US Fe de ral Re s e rve , DB Global Marke ts Re s e arch Notes: Credit impulse := change in net lending flows from financial to private non- financial sector in % of GDP; Real C+I := real private consumption + investment Deutsche Bank Thomas Mayer DB Research Chief Economist 14
  • 16. Understanding the nature of credit Where there is trust economic relations are based on credit, wherethere is no trust economic relations are based on the exchange ofmoney (David Graeber). Modern finance pretended that trust can be replaced by financialengineering. Financial engineering has flopped, trust has disappeared,and credit is being replaced by money. But will the replacement of credit by fiat money eventually lead to acrisis of the fiat money system?Deutsche Bank Thomas MayerDB Research Chief Economist 15
  • 17. Forty years of flat money 1600.00 US$ 1400.00 1200.00 15/8/1971 US$ pric e of gold end of 1000.00 $/gold link 800.00 600.00 400.00 Financial crisis 200.00 Carter dollar 0.00 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10Deutsche Bank Thomas MayerDB Research Chief Economist 16
  • 18. What are the new challenges for economists? •We need a better understanding of the credit cycle and the nature of credit in macroeconomics •We need to develop modern finance for a world of „Knightian uncertainty“ with lots of „unknown unknowns“ •We must become more inter-disciplinary with input from history, psychology, sociology and anthropology •We must rely less on developing theories by „deduction“ (like in natural sciences) and apply more „induction“ (like in social and historical sciences)Deutsche Bank Thomas MayerDB Research Chief Economist 17
  • 19. Disclaimer© Copyright 2012. Deutsche Bank AG, DB Research, D-60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite “Deutsche BankResearch”.The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author,which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinionsexpressed may differ from views set out in other documents, including research, published by Deutsche Bank. The above information is provided forinformational purposes only and without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness,completeness and accuracy of the information given or the assessments made.In Germany this information is approved and/or communicated by Deutsche Bank AG Frankfurt, authorised by Bundesanstalt für Finanzdienst-leistungsaufsicht. In the United Kingdom this information is approved and/or communicated by Deutsche Bank AG London, a member of the London StockExchange regulated by the Financial Services Authority for the conduct of investment business in the UK. This information is distributed in Hong Kong byDeutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. and in Singapore by Deutsche Bank AG, Singapore Branch. In Japanthis information is approved and/or distributed by Deutsche Securities Limited, Tokyo Branch. In Australia, retail clients should obtain a copy of a ProductDisclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether toacquire the product. .Deutsche Bank Thomas MayerDB Research Chief Economist 18

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