Big thinkers still stumped on global economic crisis
- 22 April 2013
- From the section Business
More than five years after the onset of the financial crisis, you might have thought economic policy makers would know what to do next.
Well they don't. Or at the very least, there is nothing like the kind of consensus that prevailed before the financial crisis.
The International Monetary Fund (IMF) has been hosting a conference on rethinking economic policy, organised by four experts in the area, including the IMF's own chief economist.
One of the other organisers - the Nobel Prize winner George Akerlof of the University of California - had a vivid analogy for the state of uncertainty the economics profession now faces.
"It's as if a cat has climbed this huge tree - the cat of course is this huge crisis. My view is 'oh my God the cat's going to fall and I don't know what to do'."
Another one of the organisers, David Romer also of the University of California, picked up the analogy: "The cat's been up the tree for five years. It's time to get the cat down from the tree and make sure it doesn't go back up."
The trouble for the economics profession is, according to the last of the conference hosts and another Nobel Prize winner, Joseph Stiglitz: "There is no good economic theory that explains why the cat is still up the tree".
No more cats I promise. But the analogy give a sense of the degree of uncertainty this stellar gathering of economists grappled with.
It is a very different world from the apparently more comfortable one we lived in before the crisis.
What were the key features of that world?
The main economic policy tool was in the hands of central banks. They set interest rates, raising them to keep inflation low and cutting them when the economy was weak.
Fiscal policy - government spending and taxation - was no longer seen as part of the routine toolkit for keeping the economy on an even keel.
Financial regulation was for the most part relatively light touch.
What we got was the worst financial crisis and the deepest recession for the wider economy since the Great Depression in the 1930s.
For Joseph Stiglitz, the crisis was evidence for his view that "economies are not necessarily stable or self-correcting".
There was quite a lot of support for that kind of view and for the idea that various state agencies have an important role in doing something about it.
Many favoured more financial regulation, especially measures that are intended to help stabilise the whole financial system rather than individual banks.
If you really want to know, it's called macro-prudential policy and it's an idea that has really built up a head of steam in the last few years.
One example is a limit on the size of loans relative to the price of the asset such as a house that it's used to buy - the loan-to-value ratio.
It sounds like a reasonable idea, but there was acknowledgement that these policies and their effects are not well understood.
And David Romer, one of the organisers, didn't think he had heard anything big enough to produce a really robust financial system.
Then there is monetary policy. Before the crisis the main tool was interest rates, but the toolkit has since expanded to include quantitative easing - shovelling money into the financial system hoping it will stimulate more spending.
There was support for that but it wasn't universal.
'Not a clue'
Allan Meltzer of Carnegie Mellon University in Pittsburgh Pennsylvania for one thought it was a huge amount of stimulus with very little effect.
There is also a debate about what should be the aim of monetary policy.
The idea of inflation targets gained widespread acceptance ahead of the crisis.
Now there is a debate about whether that's enough, but there was no consensus on whether change is needed.
David Romer said the approach seemed good for 15 or 20 years, but subsequently showed itself incapable of generating enough demand in the economy.
But Stefan Gerlach of Goethe University in Frankfurt argued that "it doesn't really make sense to rethink the entire monetary policy framework for an event that happens about once in a century".
There was no great enthusiasm for the rapid increase in government debt in the rich countries over the last few years, but few would go as far as the conservative view of Allan Meltzer:
"If we want financial stability, economic stability and other good things don't we begin by restricting budget deficits? Formally, indefinitely and for all future time?"
Which leaves us where? Confused? You are not the only one.
There were plenty of ideas for sure. But this is how the IMF's chief economist Olivier Blanchard put it at the end of the conference:
"We don't have a sense of our final destination… Where we end I really don't have much of a clue."
That may be disconcerting, but then the crisis has been an enormous jolt to economic policy, and it would perhaps be even more unsettling if there weren't some fundamental rethinking going on.