Long, long travel day today (and not sure if I'll have an internet connection), so -- for now -- a few quick ones (between here and today's links). First, Brad Delong sends us to David Wessel, who sends us to Olivier Blanchard (I've shortened the five points):
Olivier Blanchard’s Five Lessons for Economists From the Financial Crisis: ...Here are Mr. Blanchard's five lessons in his own words, lightly edited by The Wall Street Journal’s David Wessel:
1. Humility is in order: The Great Moderation ... convinced too many of us that the large-economy crisis - a financial crisis, a banking crisis - was a thing of the past. It wasn’t going to happen again... My generation ... knew how to do things better, not only in economics but in other fields as well. What we have learned is that's not true. History repeats itself. We should have known.
2. The financial system matters — a lot: It’s not the first time that we¹re confronted with ... “unknown unknowns”... There is another example in macro-economics: The oil shocks of the 1970s... It took a few years, more than a few years, for economists to understand what was going on. After a few years, we concluded that we could think of the oil shock as yet another macroeconomic shock. We did not need to understand the plumbing. We didn’t need to understand the details of the oil market. ...
This is different. What we have learned about the financial system is that the problem is in the plumbing and that we have to understand the plumbing..., it's very clear that the details of the plumbing matter.
3. Interconnectedness matters: This crisis started in the U.S. and across the ocean in a matter of days and weeks. Each crisis, even in small islands, potentially has effects on the rest of the world. The complexity of the cross border claims by creditors and by debtors clearly is something that many of us had not fully realized..., which countries are safe havens, and when and why? Understanding this has become absolutely essential. What happens in one part of the world cannot be ignored by the rest of the world. ...
It’s also true on the trade side. ... One absolutely striking fact of the crisis is the collapse of trade in 2009. Output went down. Trade collapsed. Countries which felt they were not terribly exposed through trade turned out to be enormously exposed.
4. We don’t know if macro-prudential tools work: It’s very clear that the traditional monetary and fiscal tools are just not good enough to deal with the very specific problems in the financial system. This has led to the development of macro-prudential tools... [Macroprudential tools allow a central bank to restrain lending in specific sectors without raising interest rates for the whole economy, such as increasing the minimum down payment required to get a mortgage, which reduces the loan-to-value ratio.] ... If there is a problem somewhere you can target the tool at the problem and not use the policy interest rate, which basically is kind of an atomic bomb without any precision.
The big question here is: How reliable are these tools? How much can they be used? The answer ... is this: They work but they don’t work great. People and institutions find ways around them. In the process of reducing the problem somewhere you tend to create distortions elsewhere.
5. Central bank independence wasn’t designed for what central banks are now asked to do: ... One of the major achievements of the last 20 years is that most central banks have become independent of elected governments. Independence was given because the mandate and the tools were very clear. The mandate was primarily inflation... The tool was some short-term interest rate that could be used by the central bank to try to achieve the inflation target. In this case, you can give some independence to the institution in charge of this because the objective is perfectly well defined, and everybody can basically observe how well the central bank does.
If you think now of central banks as having a much larger set of responsibilities and a much larger set of tools, then the issue of central bank independence becomes much more difficult. Do you actually want to give the central bank the independence to choose loan-to-value ratios without any supervision from the political process. Isn’t this going to lead to a democratic deficit in a way in which the central bank becomes too powerful? I'm sure there are ways out. Perhaps there could be independence with respect to some dimensions of monetary policy - the traditional ones — and some supervision for the rest or some interaction with a political process.