Table Of ContentIndia Studies in Business and Economics
Dilip M. Nachane
Critique of the
New Consensus
Macroeconomics
and Implications
for India
Foreword by Kaushik Basu
India Studies in Business and Economics
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Dilip M. Nachane
Critique of the New
Consensus Macroeconomics
and Implications for India
123
Dilip M.Nachane
Indira Gandhi Institute of Development
Research
Mumbai,India
ISSN 2198-0012 ISSN 2198-0020 (electronic)
India Studies inBusiness andEconomics
ISBN978-81-322-3918-5 ISBN978-81-322-3920-8 (eBook)
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To the millions who lost their bread (in the
global crisis) because of a handful who
wanted more cake
’
Foreword: Dilip M. Nachane s Macroeconomics
Dilip M. Nachane’s new book on macroeconomic theory and policy is the kind of
book that I would have loved to have had on hand, when I was Chief Economic
Adviser to the Government of India. It is a remarkably comprehensive book that
startswithareviewofthemainschoolsofmacroeconomicthought,fromKeynes’s
General Theory to contemporary models of analysis, many of them inspired by
actual policy challenges and crises, such astheglobal financialcrisis of2008. The
bookcloseswithtwochaptersdevotedexclusivelytoIndia,withaspecialfocuson
the fiscal and monetary policy concerns that India faced over the last decade. As
such,thebookshouldbevaluabletostudentsofeconomicsandtopolicymakersin
India, with an interest in macroeconomic policy, wanting a refresher course.
MacroeconomicsasadisciplineemergedwiththegroundbreakingworkofJohn
MaynardKeynesandhisaudaciousefforttobringunderoneframeworkofanalysis
theworldofmoneyandfinance,theworldofgoodsandservices,andtheworldof
labor and jobs. The emergence of Keynesian macroeconomics coincided with the
last stages of the Great Depression, and subsequently became the go-to handbook
forcounteringrecessionsandcrises.Buttheworldeconomyisacomplexorganism
thathascontinuedtospringsurprisesintermsofnewkindsofrecessionsthatwould
notrespondtostandard policypackages.Thatledtothemodificationsofoldideas
and impetus to look for new macroeconomic paradigms. There were powerful
criticisms of the Keynesian model by the Chicago school and, in particular, by
Milton Friedman that led to the doctrine of monetarism as an alternative model.
Thisbooktakesthereaderthroughthesevariousschoolsofthought,alltheway
to theNew Consensus Macroeconomics, which is presented and dissected atsome
length, showing its strengths but also casting doubt on some of its features,
including whether “consensus” is quite the right word for describing any kind of
macroeconomics.
But this is not a book on theory for the sake of theory. Having presented some
of the main theoretical schools, the book ventures to discuss real-world problems.
WelearnatlengthhowthesubprimemortgagecrisisemergedintheUSA,became
a generalized financial crisis, and then infected other markets and economies.
vii
viii Foreword:DilipM.Nachane’sMacroeconomics
By2009,thecrisishadspreadtoemergingeconomies,includingIndia.Foreign
investorsnervousabouttheglobaleconomy,beganwithdrawingtheirmoneyfrom
“distant” economies. By September 2008, the Bombay Stock Exchange Sensex
Index was plummeting. From a level of 19325.7 in January 2008, it fell to 8995.5
by March 2009. Merchandise exports to advanced economies were beginning to
stall, and by the end of 2009, GDP growth in India had sharply declined.
Having been in thepolicy worldat that time, I am acutely aware how the crisis
was part and parcel of our lives. What made the job harder was that there was no
good paradigm to fall back on. We had to use old-fashioned theory with a hand-
some dose of common sense and gut feeling, to design policy and respond to the
crisis.Therewillofcourseneverbeanexacttextbookparadigmformostreal-world
problems; intuition and common sense will always play a role. Nevertheless,
Professor Nachane’s new book tries to make some amends for the current lacuna,
by blending our theoretical knowledge of macroeconomics with the actual expe-
rienceinadvancedandemergingeconomies.Thereinliesthestrengthofthebook,
andthereasonwhystudentsofeconomicsandpractitionersofeconomicpolicycan
benefit from it.
Ithaca, USA Kaushik Basu
July 2018 Carl Marks Professor
Cornell University
Preface
TheNewConsensusMacroeconomics(NCM)whichestablisheditselfinthe1980s
as the mainstream in macroeconomics essentially represents an “uneasy truce”
between the then dominant new classical and real business cycle schools (associ-
atedwithLucas,Sargent,Wallace,Kydland,Prescott,etc.)ontheonehandandon
the other the nascent neo-Keynesian view (of Akerlof, Mankiw, Gordon, Phelps,
Taylor,etc.).ItcombinesfeatureslikeKeynesianstickypricesandwageswiththe
new classical assumptions of rational expectations and efficient markets. It also
incorporates features from classical monetarism such as thenaturalrate hypothesis
anda vertical Phillips curve. Its econometric mediumcontinued tobethedynamic
stochastic general equilibrium (DSGE) models of the real business cycle school.
NCMsetsthetoneformuchofthemacroeconomic(especiallymonetary)policy
followedbytheadvancedeconomiesintheperiodoftheGreatModeration(1990–
2005).AmongthemajorpolicyrecommendationsofNCM,specialmentionmaybe
madeof(i)inflationtargeting,(ii)Taylorrule,(iii)non-interventioninassetmarkets
(Jackson Hole consensus), (iv) light-touch regulation and (v) a strong belief in the
abilityoffinancialmarketstoregulatethemselves(marketdiscipline).Sofarasthe
emerging market economies (EMEs) are concerned, NCM (and especially its twin
pillars—the rational expectations hypothesis (REH) and the efficient-market
hypothesis (EMH)) supplied the intellectual basis for the successive waves of
financial liberalization undertaken by governments in these countries beginning in
the decade of the 1980s.
TherecentglobalcrisishasposedaveryseriouschallengetotheNCM.Firstly,
empiricalmodelsbasedonNCMfailedtoanticipatetheoccurrenceofthecrisisand
later its extent and severity. Secondly, the solutions proposed within the NCM
framework have met with limited success in the USA and actually compounded
problems in the EU. This has led to serious questioning of the NCM from four
major alternative schools,viz. thepost-Keynesian,theAustrian, theMinskyanand
the Marxist.
ix
x Preface
The above considerations constitute the underpinnings of the proposed book.
The book addresses six major questions, viz.
(i) TowhatextentwerethemacropoliciesbasedontheNCMresponsibleforthe
developments leading up to the recent global crisis?
(ii) Has the NCM theoretical framework outlived its utility and is in need of
replacement by a suitable alternative?
(iii) Do some of the other alternative theoretical frameworks provide more con-
vincing explanations of the modern-day business cycles?
(iv) Isthecurrentfocusofregulationcentredoncapitalrequirementsandmarket
discipline (Basel II to be succeeded by Basel III) appropriate?
(v) For the less-developed and emerging market economies, is financial liber-
alization (financial deregulation plus financial innovation) an unmixed
blessingoristhereabenchmarkbeyondwhichsuchliberalizationcanprove
detrimental?
(vi) What are the political economy considerations underlying the current
ongoingprocessoffinancializationinEMEsandisitinthelong-terminterest
of these nations?
Thefirstfourchaptersofthebookoutlinetheevolutionofmacroeconomicsfrom
the publication of theGeneral Theory of Keynes in 1936 to the establishment of a
broad consensus (the New Consensus Macroeconomics (NCM)) around the
mid-1980s.Chapters5and6deal,respectively,withtheoriginsoftheglobalcrisis
intheUSAanditstransmissiontotheothermajorregionsoftheworld.Chapters7
to10analysethefourmajoralternativeperspectivesontheglobalcrisisofferedby
the Austrians, the Minskyans, the post-Keynesians and the Marxists. Chapter 11
attempts to provide a consolidated overview of the main theoretical post-crisis
critique of the NCM, while Chapter 12 is devoted to a discussion of the critique
ofthepolicymixfollowedintheperiodleadinguptotheglobalcrisis.Chapter13
analyses in a Lakatosian framework, the process by which the mainstream NCM
has countered this critique and largely stood its ground, making certain ad hoc
changes while keeping the main edifice intact. While the mainstream framework
remains intact, the harsh lessons of the crisis have not been lost on the policy-
makers. The comity of nations have been unanimous in advocating a coordinated
approach to deal with global instability issues—the main partners in such a coor-
dinated approach being national regulators and international bodies such as IMF,
WTO, BIS.Chapter 14dealswiththemodalitiesoftheamendments needed tothe
national and global financial architecture to facilitate the dialogue necessary to
achieveacoordinatedresponsetocrisesthathavethepotential ofdestabilizingthe
worldtradeandinvestmentorder.ThelasttwochaptersdealwiththeIndiancasein
detail.Chapter15outlinesthemaincontoursofthefinancialsectorasithasevolved
in India over the past three decades, and the special challenges posed for the
financial regulators in a system that is being aggressively pushed towards dereg-
ulationandliberalizationbyamarket-orienteddomesticcorporatestructuretogether
withtheimperativeofparticipationintheglobalfinancialcommunity.Ouranalysis
