Are earthquakes needed to shake economics?

Ronald Schettkat

No sdp10003, Schumpeter Discussion Papers from Universitätsbibliothek Wuppertal, University Library

Abstract: The current crisis is like an earthquake for the theoretical foundations of economic policies, which have guided governments and central banks for the last few decades. The efficient market hypothesis and its application to labor markets –“natural rate theory”- dominated interpretations of economic trends and policy prescriptions since the 1970s. Public policy, public institutions, and regulations were generally regarded as distortions of the otherwise well functioning markets. Economic trends were filtered through the lens of the “natural rate theory,” focusing on labor market institutions only and putting blinds on macroeconomic influences. Therefore, the recipe was a reshaping of institutional arrangements intended to allow markets to operate more freely, i.e. to bring the real world closer to the idealized theoretical model. This paper confronts the economic trends with the interpretations of the “natural rate theory” and argues that they hardly fitting the facts. The paper argues that monetary policy gained importance in the 1970s and enforced deflationary policies – which, in turn reduced growth, especially in upswings – and allowed employment to recover to its initial pre-recession levels. Deflationary bias was also guiding the design of major EU institutions, reducing potential and actual growth.

Keywords: Economic crisis; efficient market hypothesis; natural rate theory; deflationary bias (search for similar items in EconPapers)
JEL-codes: E00 E24 E58 E6 J3 (search for similar items in EconPapers)
Pages: 30
Date: 2010-04
New Economics Papers: this item is included in nep-cba, nep-hpe, nep-mac and nep-pke
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Persistent link: https://EconPapers.repec.org/RePEc:bwu:schdps:sdp10003

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