A global perspective on the great financial insurance run.docVIP

A global perspective on the great financial insurance run: Causes, consequences, and solutions (Part 1) Ricardo Caballero23 January 2009 Print ? EmailComment ? Republish In a pair of Vox columns, one of the world’s most respected macroeconomists suggests that the consensus view of the crisis’s causes and cures is flawed. This first column focuses on the crisis’s deep causes. Global excess demand for safe assets played a role in building the ‘accident waiting’ to happen. Now, investors’ fears of unknown unknowns – Knightian uncertainty – is why the waiting mountains of cash are not acting as “stabilising speculation”. This is a financial crisis to remember. The financial losses are measured in trillions of dollars; elite financial institutions have fallen; fear and mistrust are widespread among investors and lenders; credit markets are not operating except for those with very short maturities; massive and unorthodox policy interventions are an every day occurrence; and we have been, and continue to be, on the verge of a global financial meltdown. How did we get into this situation? What should we do to get out of it and to prevent a relapse? This pair of Vox columns addresses these questions, suggesting that the consensus view of the crisis’s causes and cures is flawed. (These columns are based on a talk at MIT’s 20 January 2009 Economics Alumni dinner in New York City.) The emerging consensus There is an emerging consensus on the causes of the crisis which essentially rehashes an old list of complaints about potential excesses committed in the phase prior to the crisis. The sins include uncontrolled global imbalances, unscrupulous lenders, and an insatiable Wall Street, all of them lubricated by an ever expansionary Federal Reserve. It follows from this perspective that the appropriate policy response is to focus on reducing global imbalances, boosting financial regulation, bringing down leverage ratios, and adding bubble-control to the Fed’s mandate. I do