Two essays on the state of macroeconomics:
First, David Romer argues our recent troubles are an extreme version of an ongoing problem:
... As I will describe, my reading of the evidence is that the events of the past few years are not an aberration, but just the most extreme manifestation of a broader pattern. And the relatively modest changes of the type discussed at the conference, and that in some cases policymakers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harms.
Thus, I believe we should be asking whether there are deeper reforms that might have a large effect on the size of the shocks emanating from the financial sector, or on the ability of the economy to withstand those shocks. But there has been relatively little serious consideration of ideas for such reforms, not just at this conference but in the broader academic and policy communities. ...
He goes on to describe some changes he'd like to see, for example:
I was disappointed to see little consideration of much larger financial reforms. Let me give four examples of possible types of larger reforms:
- There were occasional mentions of very large capital requirements. For example, Allan Meltzer noted that at one time 25 percent capital for was common for banks. Should we be moving to such a system?
- Amir Sufi and Adair Turner talked about the features of debt contracts that make them inherently prone to instability. Should we be working aggressively to promote more indexation of debt contracts, more equity-like contracts, and so on?
- We can see the costs that the modern financial system has imposed on the real economy. It is not immediately clear that the benefits of the financial innovations of recent decades have been on a scale that warrants those costs. Thus, might a much simpler, 1960s- or 1970s-style financial system be better than what we have now?
- The fact that shocks emanating from the financial system sometimes impose large costs on the rest of the economy implies that there are negative externalities to some types of financial activities or financial structures, which suggests the possibility of Pigovian taxes.
So, should there be substantial taxes on certain aspects of the financial system? If so, what should be taxed – debt, leverage, size, other indicators of systemic risk, a combination, or something else altogether?
Larger-scale solutions on the macroeconomic side ...
After a long discussion, he concludes with:
After five years of catastrophic macroeconomic performance, “first steps and early lessons” – to quote the conference title – is not what we should be aiming for. Rather, we should be looking for solutions to the ongoing current crisis and strong measures to minimize the chances of anything similar happening again. I worry that the reforms we are focusing on are too small to do that, and that what is needed is a more fundamental rethinking of the design of our financial system and of our frameworks for macroeconomic policy.
Second, Joe Stiglitz:
In analyzing the most recent financial crisis, we can benefit somewhat from the misfortune of recent decades. The approximately 100 crises that have occurred during the last 30 years—as liberalization policies became dominant—have given us a wealth of experience and mountains of data. If we look over a 150 year period, we have an even richer data set.
With a century and half of clear, detailed information on crisis after crisis, the burning question is not How did this happen? but How did we ignore that long history, and think that we had solved the problems with the business cycle Believing that we had made big economic fluctuations a thing of the past took a remarkable amount of hubris....
In his lengthy essay, he goes on to discuss:
Markets are not stable, efficient, or self-correcting
- The models that focused on exogenous shocks simply misled us—the majority of the really big shocks come from within the economy.
- Economies are not self-correcting.
More than deleveraging, more than a balance sheet crisis: the need for structural transformation
- The fact that things have often gone badly in the aftermath of a financial crisis doesn’t mean they must go badly.
Reforms that are, at best, half-way measures
- The reforms undertaken so far have only tinkered at the edges.
- The crisis has brought home the importance of financial regulation for macroeconomic stability.
Deficiencies in reforms and in modeling
- The importance of credit
- A focus on the provision of credit has neither been at the center of policy discourse nor of the standard macro-models.
- There is also a lack of understanding of different kinds of finance.
- Flawed models not only lead to flawed policies, but also to flawed policy frameworks.
- Should monetary policy focus just on short term interest rates?
- Price versus quantitative interventions
Stiglitz ends with:
Take this chance to revolutionize flawed models
It should be clear that we could have done much more to prevent this crisis and to mitigate its effects. It should be clear too that we can do much more to prevent the next one. Still, through this conference and others like it, we are at least beginning to clearly identify the really big market failures, the big macroeconomic externalities, and the best policy interventions for achieving high growth, greater stability, and a better distribution of income.
To succeed, we must constantly remind ourselves that markets on their own are not going to solve these problems, and neither will a single intervention like short-term interest rates. Those facts have been proven time and again over the last century and a half.
And as daunting as the economic problems we now face are, acknowledging this will allow us to take advantage of the one big opportunity this period of economic trauma has afforded: namely, the chance to revolutionize our flawed models, and perhaps even exit from an interminable cycle of crises.