 I wanted to talk now about an alternative perspective on understanding financial markets. This is a perspective associated with John Maynard Keynes and in more modern times with an economist named Hyman Minsky. And as opposed to the theory we just talked about, which said that financial markets are kind of perfect. They're our friend. They're always helpful. This theory says that financial markets are inherently unstable and volatile, often destructive, and that they precede frequently with unsustainable price improvements, bubbles we call them in financial markets followed by crashes, followed maybe by a new bubble and a new crash. So the idea is that financial markets can be harmful unless there's sufficient government regulation to keep them from doing these very bad things. Financial markets are gambling casinos. That's the main reason why Keynes sees this differently from mainstream theory of the textbook. And again, it's the idea about what do they assume about what people know when they're in operating financial markets. So Keynes' entry point in his theory is that the future is unknowable as opposed to rational expectations where we can have perfect knowledge of the future. Keynes says that the future doesn't exist yet. It's not determined yet. And therefore, we can't know anything about it yet. So how do we make decisions, say, for whether we should buy ourself forward, and we don't know what Ford's future profits are going to be? And the answer is, we guess. We form expectations as best we can about what's likely to happen to the economy, to orders, and to Ford. And on that basis of these fallible expectations, we don't know if they're true. They're likely not to be true. They're often not true. We then decide whether to buy Ford stock or not. So what are the implications of this? The implications of this are you have to do something. You don't know the future. What do you do? Well, generally speaking, people form expectations based on what's been happening in the recent past. If the stock market has been rising in the recent past, people assume it's going to continue to rise. The longer it rises, the more people become confident that their optimism is OK. Typically when we're in a financial market, boom and things are going well, government economists, businessmen, financial newspapers tell us that this is a new era in which we're not likely to have a problem in our future financial markets. So since people expect prices to rise, they buy Ford stock or other stock. When they buy the stock, the price goes up. The price going up convinces them that they were right in their optimistic expectations and they buy more stock and so on. The most aggressive investors become the richest people. There's envy of these investors, so people want to be like them. And eventually people become so sure about the future they're going to borrow lots of money to buy the stocks and then we're into a difficult situation. So on the way up, the rising stock market and rising optimism fuels the wealth effect on consumption spending. Houses are richer, so they'll spend more money, whatever their income is. And since everyone's optimistic, they think profits are pretty good, so businesses are going to want to invest more. But at some point, profits can't grow fast enough to sustain the belief that future profits will keep rising. So at some points profits level off and people know all of a sudden feel that their optimism wasn't maybe so good. And then we shift to pessimism as profits maybe don't work so well. And then everyone wants to get out of the stock before the price falls, so that they won't get stuck with a falling price, which means that everyone starts to sell a stock and the stock price goes down. So then the financial markets crash. This is bad for the real economy. People can't get loans, the banks become nervous, and the real sector doesn't perform well. The wealth effect works in reverse, and all of a sudden we're on a downturn, and the downturn can be severe. The Keynes theory of how financial markets work gets very popular after financial market difficulties occur. So everyone is now talking about a Keynesian view on financial markets because we just came through a terrible financial crisis that we're going to talk about. So let me just give one or two historical examples of the kind of problems that come up in financial market. In the 1920s there was a tremendous financial market boom, a stock market boom, a bond market boom. Everyone began to borrow money to put money into the stock market, the stock market hit historic highs. But by 1929 and 1930, the buoyant expectations of future gains and profits began to look like maybe they weren't so secure, and the boom turned around. In the 1920s, as in all periods when there are financial market bubbles, tremendous inequality increased in the country because the richest people are most of the securities. But from 1929 to 1932, we had a stock market crash. It helped bring down the entire economy. Essentially, the crash brought us into a decade of depression in which the unemployment rate was between 17% and 25% and real GDP fell by a third. And we never got out of that depression to World War II. But it's not just ancient history. We had a stock market bubble in the late 1990s, where stock prices went up 25% a year and then fell afterwards. They're still not back now, ten years later to where they were then. And in 2000 and two to 2007, we had a housing based bubble in financial markets which crashed causing a huge global problem. And without massive government intervention, probably another great depression. So the conclusion is financial markets aren't necessarily our friend or aren't always our friend. They're dangerous and they need tight regulation.