Wrong is still wrong and should be disregarded

It is a public holiday in Australia today and I am not working a full day. But I have been collecting some items from the past five or so years which I am weaving into the text book that Randy Wray and I hope to have out in the coming year. When academics or others comment on public affairs it is clear that our commentary is to a certain extent time-dependent. The language we use, the topics we focus on and the conclusions we draw. So some things that are written sound quaint when we go back to them after some years. I hoard information and occasionally I access my databases to see who said what in some year and compare it to what might have happened in the interim and then what the same person might be saying in retrospect. It is an interesting exercise and when applied to my own profession reveals some amazingly nonsensical predictions or assessments. The global crisis has provided a major event to test many of the assessments made prior to the crisis. The most surprising thing is that the same sort of assessments made prior to the crisis that were demonstrated to be entirely false are still being made and still influencing policy design. But the most robust assessments have withstood the crisis and remain relevant today. I include the developments in Modern Monetary Theory (MMT) in this latter category. Mainstream macroeconomics was largely wrong before the crisis and is wrong now (for the same reasons) and should be disregarded.

One of the popular undergraduate textbooks in money and banking is Frederick Mishkin’s “Financial Markets and Institutions” now in 6th edition. It is a standard mainstream offering with all the myths (money multiplier; quantity theory of inflation; reserve-constrained banks etc). I have never used it in my own teaching but always get a copy sent by the publisher.

I am working on matters related to banking at the moment for our textbook and so I have been considering the way that mainstream authors portray the monetary system. That led me to combine today’s focus with some other research I have been doing.

In this context, I have also been digging a bit into the exact chain of events that led to Iceland’s bank problems. The nation’s financial system was historically small and the banks were mostly publicly-owned. The neo-liberal onslaught began in the late 1990s when the banking system was privatised along crony-lines (that is, carved up among the political elites).

The privatised banks then grew as a result of increased global capital mobility and relaxed financial regulations (particularly associated with borrowing limits and collateral).

With low taxes and less regulatory oversight, the financial sector boomed. The financial engineers were in full swing.

The September article in the New Left Review – Lessons from Iceland – describes the growing “Ponzi” natire of the growth in the financial sector:

Iceland’s new banking elite rode the bubble, intent on expanding their ownership of the country’s economy, both competing and cooperating with each other. Using their shares as collateral, they proceeded to take out large loans from their own banks, some of which they spent on buying more shares in the same banks, inflating share prices. Their executives were instructed to follow suit. They performed the same task for other clients, including the other banks. Bank A lent to shareholders in Bank B, who bought more shares in B against the shares as collateral, raising B’s share price. Bank B returned the favour for shareholders in Bank A. The net result was that the share prices of both banks rose, without new money coming in. Depositors, too, were urged to shift their savings into shares, and bank employees spent their evenings telephoning households up and down the country to this end, using tactics that could only be described as predatory lending. The result was to shield major shareholders from risk while yielding them a percentage of the very high profits.

Iceland’s financial sector growth was based on refinancing debt with extra borrowing using “fake capital” (and “illegal market manipulation”) to evade scrutiny and allow the Icelandic banks to “enter the big-bank league”.

The New Left Review article says that:

The owners and managers remunerated themselves on an ever-larger scale, effectively robbing the banks from the inside. As they grew richer, they attracted more political support; many came to believe they had the Midas touch. Their private jets, roaring in and out of Reykjavik’s airport, seemed to provide visual and auditory proof to the part-admiring, part-envious population below. Income and wealth inequality surged, helped by government policies that shifted the tax burden to the poorer half of the population.

The reason I was reading that material related to the paid work that Federick Mishkin did for the Iceland Chamber of Commerce. Here is the Report that he co-authored with an Icelandic academic economist in May 2006 – Financial Stability in Iceland.

Charles Ferguson (director of the “Inside Job”) wrote in The Chronicle of Higher Education (October 3, 2010) – Larry Summers and the Subversion of Economics that:

Frederic Mishkin, a professor at the Columbia Business School, and a member of the Federal Reserve Board from 2006 to 2008. He was paid $124,000 by the Icelandic Chamber of Commerce to write a paper praising its regulatory and banking systems, two years before the Icelandic banks’ Ponzi scheme collapsed, causing $100-billion in losses. His 2006 federal financial-disclosure form listed his net worth as $6-million to $17-million.

The opening pages of the 35-page jointly-authored report tell us how both authors are in the top of their league and experts in banking and financial markets.

The Report says it:

… provides a framework for evaluating financial fragility by examining the fundamentals of Iceland’s economy to see whether they suggest that the country could go down the traditional routes to financial instability.

It concludes that:

1. “… its financial regulation and supervision is considered to be of high quality”.

2. “Iceland’s financial sector has undergone a substantial liberalization … and its banking sector has been transformed from one focused mainly on domestic markets to one providing financial intermediation services to the rest of the world”.

3. Of the three sources of financial instability – (liberalisation; fiscal imbalances and imprudent monetary policy) – “None of these routes describe the current situation in Iceland”.

4. “Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided”.

5. “Although the banks’ reliance on external financing poses the biggest risk to the financial system right now, the probability of a credit event occurring is low”.

6. “concerns have led to criticism of Iceland’s banks for lack of transparency” but we think it is “unlikely that there are serious problems with safety and soundness in the banking system”.

7. On the possibility that “concerns about an Icelandic financial meltdown could lead to massive withdrawals out of Icelandic assets, which would then lead to a financial meltdown” they said that “research on multiple equilibria suggests that self-fulfilling prophecies are unlikely to occur when fundamentals are strong, as they are in Iceland”.

8. “The analysis in our study suggests that although Iceland’s economy does have some imbalances that will eventually be reversed, financial fragility is currently not a problem, and the likelihood of a financial meltdown is low”.

The evidence is now clear. Mishkin was completely wrong. The portents for the collapse were there for all to see (who had access to the data etc). Many commentators were predicting the meltdown.

The following year (2007) LSE Professor Richard Portes co-authored a 65-page consulting report – also for the Iceland Chamber of Commerce – The Internationalisation of Iceland’s Financial Sector which the NLR says he was paid £58,000. It was actually co-authored by Icelandic economist in collaboration with the Iceland Chamber of Commerce.

The Report “examines closely the current state of the Icelandic banks and financial sector, as well as the regulatory and macroeconomic environment”.

Here we read that:

1. “the growth of the banks has been spectacular” and in response to what they termed an “informational crisis” (“external criticism of the bank’s reliance on market funding with short maturities” etc) in 2006 they conclude that “resilience and responsiveness of the banking sector have been impressive”.

2. ” Most fundamentally, the banks exploit strong competitive advantage, arising from their entrepreneurial management, flat management structures, and unusual and strong business models”.

3. “We conclude that the Icelandic economy and financial sector are highly resilient … With regard to both the macroeconomic situation and the characteristics and performance of the banks, we consider that the current market premium on Icelandic banks is excessive relative to their risk exposure and in comparison with their Nordic peers. If this is in fact a country risk premium, we think it is not justified by Iceland’s economic situation. It is reasonable to expect the CDS spreads (for example) for Icelandic banks to return to more normal levels”.

4. “Overall, the internationalisation of the Icelandic financial sector is a remarkable success story that the markets should better acknowledge”.

I loved the conclusion that the “markets should better acknowledge” what these market-oriented ideologues think is the true situation. But history now tells us what a disgraceful input to the public debate these Reports were.

Whatever, else you might think of them – for example, the fact these academics were paid handsomely by sectoral interests to bring their “fame” and academic authority to bear so as to advance the same interests that were responsible for the evolution of the financial structure that collapsed – the plain, simple fact that cannot be escaped from is that their conclusions (based on their “expert analysis”) were wrong.

Not just a little bit wrong. If you judge the extent of the error by the financial losses that resulted – then very wrong. If you judge the extent of the error by the social and human damage that resulted – then extremely wrong.

On May 28, 2008, Mishkin resigned from his position as a governor of the US Federal Reserve and returned to academic life. The Wall Street Journal Mishkin Resigns: A Look Back – announced the decision and said that:

Mr. Mishkin may be giving up a say in monetary policy, but his return to the academic world will surely be more lucrative. His financial disclosure report, released in 2007, shows that in the year before joining the Fed in 2006, he made a tidy sum dispensing advice to central banks, governments and business groups around the world. He collected a $134,858 consulting fee from the Icelandic Chamber of Commerce; $63,188 from the Riksdagen, or Swedish Parliament, who hired him to co-write a report on the Swedish central bank; $15,600 from the Central Bank of Chile, $15,575 from the Bank of Korea, $9,161 from the Bank of Spain and $4,250 from the Bank of Canada. That was all in addition to his salary from Columbia University.

This type of information combined with how wrong Mishkin’s assessment of the Icelandic situation was is consistent with Charles Ferguson’s criticism of way that my profession has become co-opted by the financial sector:

Over the past 30 years, the economics profession—in economics departments, and in business, public policy, and law schools—has become so compromised by conflicts of interest that it now functions almost as a support group for financial services and other industries whose profits depend heavily on government policy. The route to the 2008 financial crisis, and the economic problems that still plague us, runs straight through the economics discipline. And it’s due not just to ideology; it’s also about straightforward, old-fashioned money.

Prominent academic economists (and sometimes also professors of law and public policy) are paid by companies and interest groups to testify before Congress, to write papers, to give speeches, to participate in conferences, to serve on boards of directors, to write briefs in regulatory proceedings, to defend companies in antitrust cases, and, of course, to lobby. This is now, literally, a billion-dollar industry.

Of-course none of this has stopped Mishkin. He hasn’t actually become a shrinking violet and still gets prominence as a commetator on monetary policy and his textbook is still used by universities around the world.

He is also still perpetuating the mis-information that pervades his deeply flawed Icelandic assessment. On June 22, 2009 his Wall Street Journal article – How to Get The Fed Out Of Its ‘Box’ – attacked fiscal policy as pushing up long-term interest rates.

Remember my comments about “time-dependent” conclusions.

Mishkin said:

The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up.

Quite apart from the theoretical flaws involved in this conclusion, even the empirical reality is at odds with the projections implicit in this statement.

Iceland was about to collapse under the weight of excessive deregulation and poorly operated (and corrupt) banks but Mishkin concluded that they were safe.

The US government – totally sovereign in its own currency – issues debt largely on conditions that it determines with higher bid-to-cover ratios and low yields – and Mishkin think there is great danger.

Ideology reigns supreme.

The following graph shows the evolution of the US 10-year bond yields since 1990 (data available from US Department of Treasury).

The yields continued to fall as the budget deficits rose. The demand for US bonds remained strong. Even after the ratings agencies tried to assert their relevance by downgrading US sovereign debt we know what happened – yields fell as demand rose.

In that 2009, WSJ article – Mishkin also rehearsed the usual inflation nonsense – that students are forced to learn if using his textbooks. He was following on the previous claim that the Federal Reserve would have to bail the government out by buying its debt as bond markets would surely revolt.

He said that:

Although an expansion of Treasury bond purchases by the Fed would have the benefit of lowering long-term interest rates temporarily to stimulate the economy, in the current environment it could be dangerous for two reasons. First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibility. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road.

The Federal Reserve has expanded its balance sheet dramatically since that time and inflation has been benign if not falling. It is quite clear that the mainstream assessments in this regard have failed to gain empirical traction.

The reason for that is that “time dependent” observations remain as good as the conceptual framework (that is, the “understanding”) that backs them up. Mishkin’s conceptual framework is inapplicable to the monetary system that he claims to be an expert about.

He was wrong about Iceland because his assessment was biased by a flawed mainstream monetary framework.

The same sort of assessments are still being made by the mainstream economists to the detriment of appropriate public policy.

For example, Bloomberg reported (December 25, 2011) – Noda’s ‘Urgent’ Task Is Tax Rise as Japan Debt Load Swells – that:

Prime Minister Yoshihiko Noda faces escalating pressure to secure support for higher taxes after Japan’s budget plan for the next fiscal year showed a record dependence on borrowing.

The article quoted a former high profile BOJ official who now works for a private investment bank as saying that “The government should hike the consumption tax rate and cut social security spending as soon as possible … This is urgent. We do not have the luxury of losing any more time.”

They also quoted a US economist working for the Tokyo-based Fujitsu Research Institute as saying that the VAT should be increased from its current value of 5 per cent to “at least 20 per cent” because the structural deficit “is completely out of whack because of increasing social security demands and costs.”

According to this genius:

If the government remains lazy in terms of hiking the consumption tax rate, it’s just a matter of time before the very obedient Japanese investors are no longer happy to finance the deficit.

Comments like that have been echoing throughout the world for the last 20 years or more. Japanese government bond yields remain low and bid-to-cover ratios high. Further, interest rates and inflation have been low for two decades. Without fiscal support, the Japanese economy would be in very poor shape.

These “experts” are expressing the same views that led the Japanese government to hike taxes in 1997 with the result collapse in the growth that was emerging about that time. That policy failure took around 5 years to recover from. Once fiscal support returned the economy resumed growth.

There is no danger at all that the Japanese government will ever “run out of yen”. While the Japanese government can easily require the Bank of Japan to credit bank accounts on its behalf to facilitate government spending (without any private bond issuance), I suspect the predictions of virtually immediate change in behaviour leading to a collapse in “investor” sentiment will not eventuate. If they do then there will be no problem anyway.

What is urgent in Japan is to attend to the needs of an ageing population, reducing youth suicide rates and ensuring that people have jobs to go to.

One thing that Mishkin does get right is that the concept of central bank independence is flawed although he wouldn’t express it in this way.

In a paper (first written in 2000 but finally published in final form in 2005) – (‘Monetary Policy in Japan: Problems and Solutions’ (with Takatoshi Ito) in Takatoshi Ito, Hugh Patrick and David Weinstein, eds.Reviving Japan’s Economy: Problems and Prescriptions (MIT Press: Cambridge Mass. 2005), pp. 107-143), we read in relation to the Bank of Japan purchasing “loss-making” government debt that:

Purchasing a large amount of long-term government bonds would put the balance sheet at risk if they later declined in value. A question is whether stopping non-conventional monetary policy on the ground of a concern about the balance sheet is desirable from the point of view of avoiding deflation and maximizing potential output. The Bank of Japan is part of the public sector, and any losses on the Bank’s balance sheet would be counterbalanced by gains on the central government’s balance sheet. Since the Bank of Japan should be considered as a part of the government from an accounting point of view, concern about these losses is unwarranted, unless they created political problems for the Bank. The balance sheet of the Bank of Japan should be guaranteed by the government if it makes sense for the BOJ to take risk in its operations.

While I would not have written this in the same way the point is obvious. The Bank of Japan is part of the Japanese government no matter what “institutional” arrangements are assembled to make this less clear.

The Japanese government issues the Yen and can never run out of it. It might not be able to purchase an adequate supply of goods and services in Yen at some future date to guarantee an adequate standard of living for its ageing citizens (as dependency ratios rise).

But that is a real problem rather than a “financial” problem. The challenge for the Japanese government is to ensure productivity remains high and the youth of Japan receive first-class education and employment opportunities.

Please read my blogs – Central bank independence – another faux agenda and The consolidated government – treasury and central bank – for more discussion on this point.


I thought the title of Larry Elliot’s article in the UK Guardian (December 25, 2011) – 2011 – the year the policymakers misread everything about the economy and – summed up everything that will haunt the world economy next year.

The policy makers are misreading everything because they are being poorly advised. The advisors are being taught by economists or are economists who do not understand how the monetary system operates or who chose for personal gain not to portray a correct understanding of how the monetary system operates.

The challenge in the coming year is to continue to undermine the status of the mainstream of my profession.

Back to the holiday.

That is enough for today!

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    13 Responses to Wrong is still wrong and should be disregarded

    1. Neil Wilson says:

      ” it’s just a matter of time before the very obedient Japanese investors are no longer happy to finance the deficit.”

      In that case wouldn’t they spend it, which would be stimulatory and prevent the need for the deficit in the first place.

      It’s all very easy to understand once you realise that an amount of government spending generates the same amount of tax and saving – each time, every time. If government spending doesn’t ‘finance’ the saving bit then it finances the tax bit instead.

      All you need to do to get this view is start looking at the spending cycle from the ‘spend first’ view rather than the ‘borrow first’ view.

      The only alternative to saving is spending surely.

    2. Aidan says:

      Neil Wilson –
      Investing is another alternative.

    3. Aidan says:

      Bill –

      The Japanese government issues the Yen and can never run out of it. It might not be able to purchase an adequate supply of goods and services in Yen at some future date to guarantee an adequate standard of living for its ageing citizens (as dependency ratios rise).

      But that is a real problem rather than a “financial” problem.

      Could a sovereign wealth fund be a solution to this real problem?

    4. markg says:

      What is your definition of investing?

    5. Edwin Herdman says:

      Prof. Mitchell:

      The section beginning at “Charles Ferguson (director of the “Inside Job”) wrote […]” is included twice.

      It’s a shame that folks pushing deregulation and ignoring “concerns [that] led to criticism” about transparency haven’t even had to suffer naming and shaming for the most part, let alone any serious tarnishing of their professional reputations. So thank you for pointing out one of the many worthwhile candidates.

      If anybody knows of papers like “The Rise and Fall of Project Camelot” (Cambridge and London, MIT Press, 1967, by Irving Horowitz), academia was clearly understood to suffer when it sought patronage from the military. Yet here we are four decades after, the examples multiplied; now we can add an even more voracious group of inbred and parasitic concerns gnawing at the gut of academia. The military, however literally deadly its pursuits, is at least held in check and circumspect by the need to be responsive to the public opinion and shame.* Certain of these friends of the banks (a position unfortunately becoming more and more distinct from “friends of the people”) merely have made it a policy to shape public opinion.

      * A humorous but useful example of this is reflected in a 21 April 1969 memo within the Department of the Air Force (available within the second edition of Washington Monthly’s excellent “Inside the System” by Peters and Rothchild) on the subject of “Optional War of Civilian Attire for Enlisted Personnel.” After some diversionary passages outlining the dangers of husky military types being adversely affected in morale, and in being “targeted” by “thieves, drunks, prostitutes, and other unsavory elements of our society,” the real thrust of it is that “b. There is a growing concern throughout the nation at the present time about the military influence in all departments of the government. […] We would be aggravating this national concern when several thousands of people in military uniform start working [in] close proximity to the House and Senate Office Buildings.”

      Is this what we have learned from the Watergate scandal – that the problem is government? I don’t think so. The problem is corrupt or inefficient government, but also unethical and manipulative businesses and corruption in academics – unfortunately, more of the latter than the former, today. The traumatic experiences of Vietnam and Watergate led the nation to understand and act on the problems of government – when, then, will the message be understood that business too has its problems?

    6. hamish says:

      Aidan, if my understanding of MMT is correct, a ‘sovereign wealth fund’ wouldn’t help as the problem is one of real resources, not financial. It wouldn’t matter if the money came from future governement spending, or from savings held in a special fund, if the real resources aren’t there at the time you actually need them, no amount of money can help.

      If anything something like a sovereign fund could be detrimental if it reduces present day investment in developing the real resources – eg robotics – needed to deal with tomorrows demographics.

    7. Aidan says:

      Hamish, the real resources exist somewhere in the world. The problem Bill mentioned was that it might not in future be able to purchase them in yen.

      And considering Japan’s economic position, there is no reason why a sovereign wealth fund should reduce present day investment in technology.

      Markg, I would define investing as buying something with the expectation of profiting financially from doing so.

    8. jrbarch says:

      Dear Bill,

      Could some sub-categories be added to the ‘Economics’ section of the Site Tab for next year? Thank you for an incredible effort and input in 2011. Wishing you peace, joy and prosperity for 2012.

      Cheers …

    9. Ikonoclast says:

      The real problem is the persistence and success of false ideas. In the socio-political world, empirical truth rarely prevails in the short to mid-term and often not over many generations. Only in the very long term does empirical reality prevail but by then it is too late. The damage is done, billions have suffered and the world, both civilization and ecology, is wrecked.

    10. Fed Up says:

      “One of the popular undergraduate textbooks in money and banking is Frederick Mishkin’s “Financial Markets and Institutions” now in 6th edition. It is a standard mainstream offering with all the myths (money multiplier; quantity theory of inflation; reserve-constrained banks etc). I have never used it in my own teaching but always get a copy sent by the publisher.”

      “The reason I was reading that material related to the paid work that Federick Mishkin did for the Iceland Chamber of Commerce. Here is the Report that he co-authored with an Icelandic academic economist in May 2006 – Financial Stability in Iceland.”

      mishkin is the absolute worst. He is even worse than greenspan and bernanke. That is quite an achievement.

    11. Andy says:


      Thanks for all the free education this year.
      I was going to say you’d pay tens of thousands of pounds to get the same training elsewhere then I remebered, you can’t.

      Prof Wray introduced a fascinating new related subject in his primer. The Pyramid of liabilities.
      I was wondering if, next year, you are planning to write about the shadow banking world and settlement of financial transactions that don’t go through bank reserves.

      All the best

    12. Greg says:


      Investing is a form of spending. What you are talking about would still increase GDP and decrease the need for govt “gap filling”

    13. Will Richardson says:


      Surely investing is foregone spending to increase real productive capacity, financial ‘investing’ is more akin to gambling, a form of entertainment spending?

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