Post-Keynesian Theory and a Policy for Managing Financial Market Instability and its Relevance to the Great Recession

Year 2012, Volume: 1 Issue: 3, 1 - 24, 01.09.2012

Paul Davidson

Abstract

For more than three decades, orthodox economists and policymakers, motivated by some variant of classical economic theory, have insisted that (1) government regulation of markets and large government spending policies are the cause of all our economic problems and (2) ending big government and freeing especially financial markets from government regulatory controls is the solution to those problems. In response, governments around the world have been freeing up financial markets and trying to reduce their involvement in economic matters. Yet, in 2007-8, the global economy experienced an alarming financial market meltdown that led to the Great Recession in which we are still enmeshed. To those who profess the belief that free markets produce socially optimum solutions, this paper explains why the facts do not support this conclusion. Keynes’s liquidity theory and the Post-Keynesian theory that developed from Keynes’s analysis can explain (a) why free financial markets cannot be efficient and (b) how to develop policies and institutions to reduce the possibility of financial market instability.

Keywords

Post-Keynesian theory, efficient market theory, financial market instability, uncertainty, international payments system, international monetary clearing union

Thanks

This paper was presented at the Third International Conference on Economics of the Turkish Economic Association, held on November 1-3, 2012 at Altin Yunus Hotel, Çesme, Izmir, Turkey.

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