He wants low interest rates, but if all financial institutions are required to keep large cash (or cash-equivalent) reserves, their ability to lend will be curtailed, so interest rates will rise; likewise if their leverage is limited. DeLong does not explain how he proposes to square the circle of low interest rates and conservative lending practices.

He is especially critical of Wall Street compensation practices, such as "large annual bonuses based on annual marked-to-market results." He seems to be gesturing toward the problem, discussed in my book as elsewhere, that a very small annual risk is unlikely to materialize in the immediate future, and therefore a trader may be quite willing to run the risk without regard to the fact that it will grow over time (the probability that a 1 percent annual risk will materialize sometime in the next 10 years is almost 10 percent). Financial firms deal with this problem by having "risk managers" to monitor the traders' deals. An alternative which DeLong favors is compensating traders with "long-run restricted stock" in their company rather than with annual bonuses. The problem, which he does not discuss, is that circumstances entirely outside the control of an individual trader may influence the price of his company's stock. This problem makes it easy to see why such a compensation practice did not emerge in the competition of banks for talent.

DeLong does not discuss my effort in the book to explain how a regime of artificially depressed interest rates and weak regulation gives bankers rational incentives to increase leverage and make risky loans. His claim that lunatics are responsible for our current economic troubles is asserted rather than argued.

He ends his review by saying that I failed to conclude that the economic crisis was the product of a "private-sector failure" rather than a failure of government "because to get there, he [that is, I] would have had to begin his book by acknowledging that it matters that the earth revolves around the sun." Earlier in his review he had compared me to Jesuit astronomers who rejected Copernicus's heliocentric theory. He seems to have a curious religious obsession. At one point in the review he says that "the litany of financial lunacy is longer than even the Eastern Orthodox litancy of the saints."

What is one to make of such a review? It seems that DeLong, like Paul Krugman, is a high road / low road thinker/writer. He does sober academic writing part of the time and irresponsible popular writing the rest of the time. That's a common enough pattern, but when it is found in macroeconomists, specifically those who write about the business cycle rather than less ideologically charged macroeconomic topics, it makes one wonder how trustworthy their "scientific" writings are. The economics of the business cycle, as I argue in my book and in earlier entries in this blog, is a weak area of economics, partly because of the difficulty of conducting cogent empirical studies, partly because of stubborn theoretical disagreements (a problem closely related to the empirical difficulties--the rival theories can't be discriminated empirically), partly because of the high ideological stakes and resulting politicization of academic controversy. One can only hope that Professor DeLong is able to keep the two parts of his intellectual life properly separated.

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