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Critique of the new consensus macroeconomics and implications for india

India 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


The Indian economy is considered to be one of the fastest growing economies of the
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More information about this series at http://www.springer.com/series/11234


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 in Business and Economics
ISBN 978-81-322-3918-5
ISBN 978-81-322-3920-8 (eBook)
https://doi.org/10.1007/978-81-322-3920-8
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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
starts with a review of the main schools of macroeconomic thought, from Keynes’s
General Theory to contemporary models of analysis, many of them inspired by
actual policy challenges and crises, such as the global financial crisis of 2008. The
book closes with two chapters devoted exclusively to India, with a special focus on
the fiscal and monetary policy concerns that India faced over the last decade. As
such, the book should be valuable to students of economics and to policymakers in
India, with an interest in macroeconomic policy, wanting a refresher course.
Macroeconomics as a discipline emerged with the groundbreaking work of John
Maynard Keynes and his audacious effort to bring under one framework of analysis
the world of money and finance, the world of goods and services, and the world of
labor and jobs. The emergence of Keynesian macroeconomics coincided with the
last stages of the Great Depression, and subsequently became the go-to handbook
for countering recessions and crises. But the world economy is a complex organism
that has continued to spring surprises in terms of new kinds of recessions that would
not respond to standard policy packages. That led to the modifications of old ideas
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.
This book takes the reader through these various schools of thought, all the way
to the New Consensus Macroeconomics, which is presented and dissected at some
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.
We learn at length how the subprime mortgage crisis emerged in the USA, became
a generalized financial crisis, and then infected other markets and economies.

vii


viii

Foreword: Dilip M. Nachane’s Macroeconomics

By 2009, the crisis had spread to emerging economies, including India. Foreign
investors nervous about the global economy, began withdrawing their money from
“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 the policy world at 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 handsome dose of common sense and gut feeling, to design policy and respond to the
crisis. There will of course never be an exact textbook paradigm for most real-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 experience in advanced and emerging economies. Therein lies the strength of the book,
and the reason why students of economics and practitioners of economic policy can
benefit from it.
Ithaca, USA
July 2018

Kaushik Basu
Carl Marks Professor
Cornell University


Preface

The New Consensus Macroeconomics (NCM) which established itself in the 1980s
as the mainstream in macroeconomics essentially represents an “uneasy truce”
between the then dominant new classical and real business cycle schools (associated with Lucas, Sargent, Wallace, Kydland, Prescott, etc.) on the one hand and on
the other the nascent neo-Keynesian view (of Akerlof, Mankiw, Gordon, Phelps,
Taylor, etc .). It combines features like Keynesian sticky prices and wages with the
new classical assumptions of rational expectations and efficient markets. It also
incorporates features from classical monetarism such as the natural rate hypothesis
and a vertical Phillips curve. Its econometric medium continued to be the dynamic
stochastic general equilibrium (DSGE) models of the real business cycle school.
NCM sets the tone for much of the macroeconomic (especially monetary) policy
followed by the advanced economies in the period of the Great Moderation (1990–
2005). Among the major policy recommendations of NCM, special mention may be
made of (i) inflation targeting, (ii) Taylor rule, (iii) non-intervention in asset markets
(Jackson Hole consensus), (iv) light-touch regulation and (v) a strong belief in the
ability of financial markets to regulate themselves (market discipline). So far as the
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.
The recent global crisis has posed a very serious challenge to the NCM. Firstly,
empirical models based on NCM failed to anticipate the occurrence of the crisis and
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. the post-Keynesian, the Austrian, the Minskyan and
the Marxist.

ix


x

Preface

The above considerations constitute the underpinnings of the proposed book.
The book addresses six major questions, viz.
(i) To what extent were the macropolicies based on the NCM responsible for the
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 convincing explanations of the modern-day business cycles?
(iv) Is the current focus of regulation centred on capital requirements and market
discipline (Basel II to be succeeded by Basel III) appropriate?
(v) For the less-developed and emerging market economies, is financial liberalization (financial deregulation plus financial innovation) an unmixed
blessing or is there a benchmark beyond which such liberalization can prove
detrimental?
(vi) What are the political economy considerations underlying the current
ongoing process of financialization in EMEs and is it in the long-term interest
of these nations?
The first four chapters of the book outline the evolution of macroeconomics from
the publication of the General Theory of Keynes in 1936 to the establishment of a
broad consensus (the New Consensus Macroeconomics (NCM)) around the
mid-1980s. Chapters 5 and 6 deal, respectively, with the origins of the global crisis
in the USA and its transmission to the other major regions of the world. Chapters 7
to 10 analyse the four major alternative perspectives on the global crisis offered by
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
of the policy mix followed in the period leading up to the global crisis. Chapter 13
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 policymakers. The comity of nations have been unanimous in advocating a coordinated
approach to deal with global instability issues—the main partners in such a coordinated approach being national regulators and international bodies such as IMF,
WTO, BIS. Chapter 14 deals with the modalities of the amendments needed to the
national and global financial architecture to facilitate the dialogue necessary to
achieve a coordinated response to crises that have the potential of destabilizing the
world trade and investment order. The last two chapters deal with the Indian case in
detail. Chapter 15 outlines the main contours of the financial sector as it has evolved
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 deregulation and liberalization by a market-oriented domestic corporate structure together
with the imperative of participation in the global financial community. Our analysis


Preface

xi

leads us to a somewhat critical assessment of the financial sector policies followed
in India since the initiation of reforms in 1991. In particular, we feel that the road
map carved out for India’s financial sector, by the two recent official reports (Percy
Mistry and Raghuram Rajan), presents several pitfalls. In the concluding chapter,
we analyse these pitfalls and suggest safeguards which need to be in place for a
proper dovetailing of the financial sector into the rest of the macroeconomy.
I must record my appreciation of the excellent library and computer facilities
provided by IGIDR, which were of great assistance to me in the writing of this
book. My particular thanks to Dr. Mahendra Dev, Director, IGIDR, for his unfailing
enthusiasm and encouragement in the writing of this book. IGIDR is an intellectually vibrant place, and discussions with colleagues like Drs. Ashima Goyal,
Naveen Srinivasan, Subrata and Jayati Sarkar, and Rajendra Vaidya have always
been fruitful. My long-standing friend, Dr. Vikas Chitre, encouraged me in the
writing of this book and read the drafts of some chapters, providing incisive
comments, which have benefitted me enormously. Mahesh Mohan provided
much-needed secretarial help, and my student, Aditi Chaubal, was a great help with
the figures and references. To all of them, I extend my heartfelt thanks.
It is indeed a felicitous happening for the book that a person of Dr. Kaushik
Basu’s eminence agreed to write the Foreword. No words can adequately convey
my profound gratitude to him for sparing so much valuable time for this task.
I express similar sentiments towards Drs. C. Rangarajan, Y.V.Reddy, Kunal Sen, R.
Barman, Vikas Chitre, Errol D’Souza and Tirthankar Roy. Their good wishes
constitute a happy augury for the book’s fortunes.
The book would never have been completed without the active assistance and
encouragement of the entire Springer team led by Ms. Sagarika Ghosh. Her
countless gentle reminders, endless deadline extensions and continuous encouragement kept the book on the right track. Ms. Nupoor Singh was of great help with
her editorial guidance, and Ms. Krati Srivastava did a splendid job with the
supervision and execution of the printing process.
Finally, my wife, Prafulla, has always been a tower of strength for all my
endeavours. My daughters, Bhagyashree and Aparna, have energetically spurred
me on, under the (possibly mistaken) impression that I was doing something really
worthwhile. No words would suffice to thank them, as well as my sons-in-law and
grandchildren. I only hope that this book does not disillusion them.
Mumbai, India

Dilip M. Nachane


What Do the Experts Say

“Prof. Nachane has written an extremely thought provoking book on Macroeconomics. It is a masterly analysis of the post Keynesian developments. The coverage
is wide, almost encyclopedic. He also traces meticulously the theoretical underpinnings of the various policy measures introduced particularly after 2008 crisis.
The jury is still out on what the ‘optimum’ level of ‘financialization’ is. A must-read
book for every serious student of economics.”
—C. Rangarajan, Former Governor of Reserve Bank of India
and Former Chairman, Economic Advisory Council to the Prime Minister
“The book is a unique and unparalleled treatment of a complex subject by an
eminent economist, which is a must read for academicians, policy makers and
financial market participants. It reflects the author’s acknowledged command over
the theory and practice of economic policies globally, and his decades of
involvement in research and policy in India in the areas of money and finance. The
book should prove of immense contemporary value in India, where money and
finance are currently under stress.”
—Dr. Y. V. Reddy, Former Governor, Reserve Bank of India
“Following the Global Financial Crisis of 2008, the basic tenets of mainstream
macroeconomics have been increasingly questioned. Dilip Nachane’s authoritative
book provides an insightful survey of the debates in modern macroeconomics. The
sweep of the book is remarkable, from Marxian and Austrian economics to the New
Consensus Macroeconomics. The book is a must-read for all scholars and students
of economics.”
—Dr. Kunal Sen, Professor of Development Economics, University
of Manchester, UK; and Director-Designate of UNU-WIDER

xiii


xiv

What Do the Experts Say

“Professor Dilip Nachane has achieved a unique feat. He elucidates the emergence
and the content of the New Consensus Macroeconomics, the post-crisis critiques of
it from a spectrum of perspectives encompassing the Austrian, the Post-Keynesian,
the Minskyan, and the Marxist, and the hard lessons learnt from the crisis by the
policy makers. Arguing the need for monetary and financial stability for economic
growth and social welfare, he critically analyses the macroeconomic policies and
the institutional and political economy aspects of financial liberalization for
achieving this purpose, in the context of India.”
—Prof. Vikas Chitre, Former Director, Gokhale Institute of Politics and
Economics, Pune, India
“In Macroeconomics history has affected the evolution of economic thought which
in turn has had a feedback on the course of history itself as this timely book reveals.
Keynes broke with the Classics but Friedman later brought Classical principles back
in. Dilip Nachane’s insightful book provides a perspective on these intellectual
developments that were associated with the Great Moderation of business cycles and
the Great Financial Crisis. It reviews this seemingly chaotic history, and critically
examines the political economy of policies around financial intermediation and
stability and the regulation of the financial sector.”
—Prof. Errol D’Souza, Director, IIM-A (Ahmedabad)
“This is a book by a leading economist which is a master piece on macroeconomics –
tracing the evolution of different schools of thought and the rationale behind them. It
is a work of great scholarship and is thought provoking, which will be very useful
even for a non-specialist.”
—Dr. R. Barman, Chairman, National Statistical Commission,
Government of India
“Written with clarity and insight, this book by a leading macroeconomist of India
explains the historical context in which a consensus emerged within modern
macroeconomic thought, and how that consensus changed history. A fascinating
read, and a work of outstanding scholarship.”
—Prof. Tirthankar Roy, Professor of Economic History,
London School of Economics


Contents

1

2

Keynesian Economics: Brief Overview . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Keynesian Economics . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.1 Main Constituents of the Keynesian Framework . . . .
3 The IS-LM Synthesis . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1 Hicks’ IS-LM Synthesis . . . . . . . . . . . . . . . . . . . . .
3.2 Keynes and the IS-LM Analysis . . . . . . . . . . . . . . .
4 IS-LM Keynesianism . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.1 Real Balance Effect and Wage Flexibility . . . . . . . .
4.2 The Phillips Curve . . . . . . . . . . . . . . . . . . . . . . . . .
4.3 Keynes and General Equilibrium . . . . . . . . . . . . . . .
5 IS-LM Analysis for an Open Economy: Mundell–Fleming
Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.1 The Basic Model . . . . . . . . . . . . . . . . . . . . . . . . . .
5.2 Monetary and Fiscal Policy Effectiveness Under
Fixed Exchange Rates . . . . . . . . . . . . . . . . . . . . . . .
5.3 Monetary and Fiscal Policy Effectiveness Under
Flexible Exchange Rates . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Resurgence of Neoclassicism . . . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Monetarism: Main Tenets . . . . . . . . . . . . . . . . . . . . .
2.1 Characteristics of Monetarism . . . . . . . . . . . . . .
3 Friedman’s “Modern” Quantity Theory of Money . . .
3.1 Modern Quantity Theory . . . . . . . . . . . . . . . . . .
3.2 Supply of Money . . . . . . . . . . . . . . . . . . . . . . .
4 The Phillip’s Curve and the Natural Rate Hypothesis .
4.1 Expectations-Augmented Phillips Curve . . . . . . .
4.2 Accelerationist Hypothesis and NAIRU . . . . . . .

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xv


xvi

Contents

5 A Monetary Policy Rule . . . . .
6 Flexible Exchange Rates . . . . .
7 Monetarism: Decline and Fall .
References . . . . . . . . . . . . . . . . .
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New Classical Economics and Real Business Cycle Theory .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Four Basic Tenets of New Classical Theory . . . . . . . . . . .
2.1 Micro-foundations . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2 Complete Markets, Continuous Equilibrium and Gross
Substitutability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.3 Rational Expectations . . . . . . . . . . . . . . . . . . . . . . . .
2.4 Neutrality of Money . . . . . . . . . . . . . . . . . . . . . . . . .
3 Main Policy Implications . . . . . . . . . . . . . . . . . . . . . . . . .
3.1 Lucas Aggregate Supply Function and Equilibrium
Business Cycle Theory . . . . . . . . . . . . . . . . . . . . . . .
3.2 Anticipated Nominal Demand Shocks Do not Matter .
3.3 Lucas Critique . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.4 Ineffectiveness of Feedback Policy Rules . . . . . . . . . .
3.5 Ricardian Equivalence . . . . . . . . . . . . . . . . . . . . . . . .
4 Real Business Cycles Theory . . . . . . . . . . . . . . . . . . . . . .
4.1 Basic Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.2 A Formal Model . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3 An Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Towards a New Synthesis: New Consensus Macroeconomics
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Neo-Keynesian School: Role of Rigidities . . . . . . . . . . . . . .
2.1 Nominal Rigidities . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2 Real Rigidities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3 Hysteresis and the Natural Rate of Unemployment . . . . . . . .
3.1 NRU Influenced by Cyclical Factors . . . . . . . . . . . . . .
3.2 A Role for Stabilization Policy . . . . . . . . . . . . . . . . . .
4 Multiple Equilibria and Coordination Failure . . . . . . . . . . . .
5 New Consensus Macroeconomics (NCM): Theoretical
Aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.2 Main Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6 Monetary Policy in the NCM . . . . . . . . . . . . . . . . . . . . . . .
6.1 Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.2 Taylor Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.3 Monetary Policy and Asset Prices . . . . . . . . . . . . . . . .

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Contents

xvii

7 The Monetary Policy Framework of the NCM . . . . . . . . . . . . . . . . 103
8 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Inception of the Global Crisis in the USA . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Long-Term Factors . . . . . . . . . . . . . . . . . . . . . . . . .
2.1 The Great Moderation . . . . . . . . . . . . . . . . . . .
2.2 Global Imbalances . . . . . . . . . . . . . . . . . . . . .
3 Medium-Term Factors . . . . . . . . . . . . . . . . . . . . . .
3.1 Inappropriate Monetary Policies . . . . . . . . . . .
3.2 Structural Flaws in the US Financial System . .
3.3 Lax Regulation of the US Financial Sector . . .
3.4 Bursting of the US Real Estate Bubble and the
Unfolding of the Crisis . . . . . . . . . . . . . . . . . .
4 US Policy Responses to the Crisis . . . . . . . . . . . . .
4.1 Conventional Monetary Policy . . . . . . . . . . . .
4.2 Unconventional Monetary Policy . . . . . . . . . . .
4.3 Fiscal Stimulus . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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6

Universalization of the US Financial Crisis . . . .
1 Contagion to the Rest of the World . . . . . . . . .
2 Crisis Spreads to Europe . . . . . . . . . . . . . . . .
2.1 Crisis Transmission from the USA to EU
2.2 Euro Area Policies . . . . . . . . . . . . . . . . .
2.3 Policies in the UK . . . . . . . . . . . . . . . . .
3 The Crisis and Asia . . . . . . . . . . . . . . . . . . . .
3.1 China and the Global Crisis . . . . . . . . . .
3.2 India in the Global Crisis . . . . . . . . . . . .
3.3 Crisis and ASEAN 5 . . . . . . . . . . . . . . .
4 Crisis and the African Continent . . . . . . . . . . .
5 Crisis and Latin America and The Caribbean . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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7

Austrian Business Cycle Theory and the GFC .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Haberler’s “Hydraulic” Version of the Austrian
3 Criticisms of the “Hydraulic” Version . . . . . . .
4 The Austrian Theory: A Restatement . . . . . . . .
5 The Austrian View of the GFC . . . . . . . . . . . .

.......
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xviii

Contents

6 Policy Recommendations . . . . . . . . . . . . . .
6.1 Monetary Policy . . . . . . . . . . . . . . . . .
6.2 Productive Macroprudential Regulation
6.3 Real Sector Recommendations . . . . . . .
7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . .

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8

The Crisis: A Minsky Moment? . . . . . . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Minsky’s Theory of Investment . . . . . . . . . . . . . . . . . . . .
3 Financial Instability Hypothesis (FIH) . . . . . . . . . . . . . . .
4 Disruption by a “Not Unusual” Event . . . . . . . . . . . . . . .
5 Debt Deflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6 Floors and Ceilings . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7 Global Crisis: Collapse of “Money Manager” Capitalism?
7.1 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.2 “Money Manager” Capitalism . . . . . . . . . . . . . . . . .
7.3 Triggers for the Crisis . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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193
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9

The Global Crisis According to Post-Keynesians .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Post-Keynesian Perspective on the Crisis . . . . . .
3 FIH Applied to Households . . . . . . . . . . . . . . .
4 Financial Fragility in the Global Context . . . . . .
5 Herd Behaviour of Investors . . . . . . . . . . . . . . .
6 Endogeneity of Money . . . . . . . . . . . . . . . . . . .
7 Income Inequality and the Crisis . . . . . . . . . . . .
8 Godley’s Seven Unsustainable Processes . . . . . .
9 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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10 Marxian Perspective on the Global Crisis: “Povorot”
or “Perelom”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1 Marxian Crisis Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Stable Capitalism Phase in the USA (1890–1970) . . . . . . . . . . .
2.1 Real Wage Trends (up to the Late 1970s) . . . . . . . . . . . . .
2.2 Stabilization Strategies of Capitalism . . . . . . . . . . . . . . . . .
3 Marxism and the Current Crisis in the USA . . . . . . . . . . . . . . .
3.1 Reversal of Real Wage Trends (Post-1970s) and the Eruption
of the Current Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.2 Weakening of Stabilization Factors . . . . . . . . . . . . . . . . . .
4 Marxian Solutions to the Crisis . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Contents

xix

11 The Post-crisis Critique of the NCM: Theoretical Aspects . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Representative Agent Equilibrium Models and Reductionism
3 Rational Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4 Transversality Condition . . . . . . . . . . . . . . . . . . . . . . . . . . .
5 Nature of Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6 Complete and Efficient Markets . . . . . . . . . . . . . . . . . . . . .
7 RBC and DSGE Models . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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233
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12 NCM Critique: Policy Implications . . . . . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Rethinking Monetary Policy in the Wake of the Crisis . . . .
2.1 “Slipping Transmission Belt” Syndrome . . . . . . . . . .
2.2 Inflation Targeting, Asset Prices and Monetary Policy
2.3 Monetary Policy and Asset Prices—The Jackson Hole
Consensus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3 Redefining the Role of Fiscal Policy . . . . . . . . . . . . . . . . .
4 Regulatory and Supervisory Policy . . . . . . . . . . . . . . . . . .
5 Limitations of DSGE Models for Policy . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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255
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262
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270

13 Post-crisis NCM Theory Adaptations: Evolutionary,
Revolutionary or Cosmetic? . . . . . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Methodological Considerations . . . . . . . . . . . . . . . .
3 Mainstream Reactions to the Crisis . . . . . . . . . . . . .
3.1 The Loyalist’ Stand . . . . . . . . . . . . . . . . . . . .
3.2 The Position of the Moderates . . . . . . . . . . . . .
3.3 The Insider Critics . . . . . . . . . . . . . . . . . . . . .
4 The NCM Controversy in a Lakatosian Framework .
4.1 The Lakatosian Framework . . . . . . . . . . . . . . .
4.2 The NCM and the Post-crisis Critique . . . . . . .
5 Perpetuation of the NCM Paradigm . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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14 Revisiting Domestic and Global Macroeconomic Policy
in the Aftermath of the Global Crisis . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Role of National Policy-Making Bodies: Post-crisis
Perspectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3 Central Bank Jurisdiction: Rethinking Monetary Policy
3.1 Asset Prices and Financial Fragility—the Jackson
Hole Consensus (JHC) . . . . . . . . . . . . . . . . . . . .

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xx

Contents

3.2 IT and Nominal Exchange Rate . . . . . . . . . . . . . . . . .
3.3 IT and Fiscal Dominance . . . . . . . . . . . . . . . . . . . . .
4 Financial Regulatory & Supervisory Authority Jurisdiction .
4.1 From Micro-prudential to Macroprudential Regulation
4.2 Strengthening and Expanding the Scope of Regulation
and Supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3 Reinforcing Prudential Standards . . . . . . . . . . . . . . . .
4.4 Devising Market Incentives for Prudent Behaviour . . .
4.5 Early Warning and Prompt Corrective Action System
(EWPCAS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.6 Reducing Costs of Financial Failures . . . . . . . . . . . . .
5 Measures Under Government Jurisdiction . . . . . . . . . . . . .
5.1 Revisiting Full Capital Account Convertibility . . . . . .
6 Role of the IMF and Proposed Reforms . . . . . . . . . . . . . .
7 International Advisory Groups . . . . . . . . . . . . . . . . . . . . .
7.1 G20 and Its Role . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.2 Financial Stability Forum (FSF)/Board . . . . . . . . . . . .
8 International Financial Standard-Setting Bodies . . . . . . . . .
8.1 The Bank for International Settlements (BIS) . . . . . . .
8.2 International Organization of Securities Commissions
(IOSCO) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15 Sustaining Growth with Monetary and Financial Stability
in India: An Appraisal . . . . . . . . . . . . . . . . . . . . . . . . . . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.1 Brief History . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2 Urjit Patel Committee (2014) . . . . . . . . . . . . . . . . .
2.3 Alternatives to Inflation Targeting . . . . . . . . . . . . . .
3 Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4 Financial Regulatory and Supervisory Policy . . . . . . . . . .
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.2 Special Regulatory Authority . . . . . . . . . . . . . . . . . .
4.3 Coordination Among Regulators . . . . . . . . . . . . . . .
4.4 Strengthening and Expanding the Scope of R and S
to the Shadow Banking Sector . . . . . . . . . . . . . . . .
4.5 Reinforcing Prudential Standards for Financial
Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.6 Market Incentives for Prudent Behaviour/Market
Discipline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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355
355
356
356
358
359
362
369
369
369
370

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. . . . . . . 374
. . . . . . . 379


Contents

xxi

4.7 Reducing Cost of Financial Failures . . . . . . . . . . . . . . . . . . . 381
4.8 Emphasis on Macroprudential Regulation . . . . . . . . . . . . . . . . 386
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388
16 By Way of Conclusion: Selected Issues in Designing
a New Architecture for the Indian Financial Sector . .
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2 HPEC and CFSR Reports: A Critical Appraisal . . . . .
2.1 General Features . . . . . . . . . . . . . . . . . . . . . . . .
2.2 Principles-Based Versus Rules-Based Regulation
2.3 Integration of Financial Trading Regulation
and Supervision . . . . . . . . . . . . . . . . . . . . . . . .
3 Financial Sector Legislative Reforms Commission
(FSLRC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4 Regulatory and Supervisory Independence:
A Neglected Issue . . . . . . . . . . . . . . . . . . . . . . . . . .
5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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393
393
394
394
396

. . . . . . . . . . 397
. . . . . . . . . . 399
. . . . . . . . . . 401
. . . . . . . . . . 404
. . . . . . . . . . 405


Abbreviations

AA
ABRR
ABS
ABSPP
ACE
ADB
ADR
AIF
AIPAC
AMEs
HPEC
IAIS
IBBI
IBC
ICA
ICAI
IEC
IFRS
IIFC
ILO
IMF
INR
IOSCO
IPA
IRDAI
IRF-FC
IR-TG
IRS
IT
IUs

Adjudicating Authority
Asset –based Reserve Requirements
Asset-based Securities
Asset-based Securities Purchase Programme
Agent-based Computational Economics
Asian Development Bank
American Depository Receipts
Alternative Investment Funds
Alternative Investment Policy Advisory Committee
Advanced eCompanies
High-Powered Expert Committee (Percy Mistry Committee)
International Association of Insurance Supervisors
Insolvency and Bankruptcy Board of India
Insolvency and Bankruptcy Code
Inter-Creditor Agreement
Institute of Chartered Accountants of India
Independent Evaluation Committee
International Financial Reporting Standards
India Infrastructure Finance Company
International Labour Organization
International Monetary Fund
Indian rupee
International Organization of Securities Commissions
Insolvency Professional Agency
Insurance Regulatory & Development Authority of India
Inter-regulatory Forum for Monitoring Financial Conglomerates
Inter-regulatory Technical Group
Interest Rate Swaps
Inflation Targeting
Information Utilities

xxiii


xxiv

JHC
JLF
LBRR
LCR
LDC
LR
LTV
MAP
MBS
MEC
MFMG
MIS
MMMF
MNREGA
MPC
MRO
MTM
MURI
NABARD
NAIRU
NASDAQ
NBFC
NCEUS
NCLT
NCM
NFE
NGO
NHB
NINA
NIVA
NPA
NRH
NRI
NSE
NSI-D-NBFC
OICV
OLA
OLIR
OTC-D
PCA
PDCF
PDMA

Abbreviations

Jackson Hole Consensus
Joint Lenders’ Forum
Liability Based Reserve Requirements
Liquidity Coverage Ratio
Less Developed Country
Leverage Ratio
Loan to Value Ratio
Mutual Assessment Process
Mortgage Based Security
Marginal Efficiency of Capital
Macro-Financial Monitoring Group
Management Information Systems
Money Market Mutual Fund
Mahatma Gandhi National Rural Employment Guarantee Act
Monetary Policy Committee
Main Refinancing Operations
Mark to Market
Minimum Unemployment Rate of Inflation
National Bank for Agriculture and Rural Development
Non-Accelerating Inflation Rate of Unemployment
National Association of Securities Dealers’ Automated Quotation
Non-Bank Financial Company
National Commission for Enterprises in the Unorganized Sector
National Company Law Tribunal
New Consensus macroeconomics
Non-financial Entities
Non-Governmental Organization
National Housing Bank
No Income, No Assets
No Income, Verified Assets
Non-Performing Asset
Natural Rate Hypothesis
Non-Resident Indian
National Stock Exchange (India)
Non-Systematically Important Deposit Accepting Non-Bank
Financial Companies
Organisation Internationale des Commissions de Valeurs
Orderly Liquidation Authority
Optimum Long-run Inflation Rate
Over-the-Counter Derivatives
Prompt Corrective Action
Primary Dealer Credit Facility
Public Debt Management Agency


Abbreviations

xxv

PFRDA
PPM
PPP
QE
R&S
RBI
RBP
RD
REER
REH/RET
RWA
SARFAESI

Pension Fund Regulatory & Development Authority
Private Placement Memorandum
Purchasing Power Parity
Quantitative Easing
Regulation & Supervision
Reserve Bank of India
Risk-based Premium
Revenue Deficit
Real Effective Exchange Rate
Rational Expectations Hypothesis/Theory
Risk-Weighted Assets
Securitisation and Reconstruction of Financial Assets and
Enforcement of Securities Interest Act
Securities Appellate Tribunal
Special Drawing Rights
Securities and Exchange Board of India
Securities Exchange Commission
Stability & Growth Pact
Small Industries Development Bank of India
Systematically Important Deposit Accepting Non-Bank Financial
Companies
Systematically Important Financial Institutions
Special Investment Vehicles
Stated Income, Verified Assets
Statutory Liquidity Ratio
Special Mention Accounts
Securities Market Programme
Special Purpose Entity
Special Purpose Vehicles
Single Resolution Mechanism
Scientific Research Programme
Total Loss Absorbing Capacity
Term Securities Lending Facility
Trip Wires & Speed Bumps
U/nit Linked Insurance Plan
United Nations Conference on Trade and Development
United Nations Development Programme
Urjit Patel Committee
Unremunerated Reserve Requirements
Value-at-Risk
Vector Auto-regression
Very Long-term Refinancing Operations
Variation Margin

SAT
SDR
SEBI
SEC
SGP
SIDBI
SI-D-NBFC
SIFI
SIV
SIVA
SLR
SMA
SMP
SPE
SPV
SRM
SRP
TLAC
TSLF
TW-SB
ULIP
UNCTAD
UNDP
UPC
URR
VaR
VAR
VLTRO
VM


xxvi

WARP
WB
WMA
WTO
ZLB

Abbreviations

(Wald’s) Weak Axiom of Revealed Preference
World Bank
Ways & Means Advances
World Trade Organization
Zero Lower Bound


About the Author

Dilip M. Nachane is currently Chancellor, University of Manipur, Imphal, India;
Professor Emeritus, Indira Gandhi Institute of Development Research (IGIDR),
Mumbai, India; National Fellow, Indian Council of Social Science Research
(ICSSR); Honorary Fellow, Institute of South Asian Studies (ISAS), National
University of Singapore; and Honorary Fellow, Indian School of Political
Economy, Pune, India. He has earlier served as Director, Department of Economics,
University of Mumbai (1993–1999); Vice Chancellor, IGIDR (2007–2010);
Visiting Professor, University of British Columbia, Vancouver, Canada (1988–
1989); Visiting Professor, University of Ulster, UK (1991–1992); Hallsworth
Fellow, University of Manchester, UK (1987–1988); and Fulbright Fellow,
University of Texas, Austin, USA (1982–1983). He has served on several official
committees such as Technical Advisory Committee on Monetary Policy, Reserve
Bank of India (2005–2011), and Member, Vijay Kelkar Committee on Regional
Imbalances in Maharashtra (Government of Maharashtra, 2011 onwards). He was
elected President of the Indian Econometric Society (TIES) (2002–2003). He has
been continuously listed in Marquis’ International Who’s Who for the last 15 years.
For his outstanding contributions to research and teaching of economics in India, he
received the UGC Pranavananda Saraswati Award for Best Teacher in Economics,
2004. He has published the following book with the Oxford University Press,
“India Econometrics: Theoretical Foundations’ and ‘Empirical Perspectives”. He
has also edited/coedited seven volumes including the “India Development Report
2011”. He is currently Editor-in-Chief of the Journal of Quantitative Economics
(Springer), and Coeditor of Macroeconomics and Finance in Emerging Market
Economies (Taylor and Francis).

xxvii


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