14th September 2012
Into the void stepped politicians and central bankers wielding a newly rediscovered sense of purpose and, for the first time in decades, the ability to rewrite the policy assumptions that had led the system to the brink. Almost four years later, however, and shrugging off those old habits has proven far harder than it seemed.
The aftermath of the collapse of Lehman Brothers on September 15, 2008 represented the nadir of free market capitalism. Such was the impact of the near-collapse of the global financial system that even arch-free marketers like former Federal Reserve chairman Alan Greenspan was forced to concede:
"This modern risk-management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."
The response from policymakers was a period of "unprecedented international policy coordination", in the words of Greenspan's successor Ben Bernanke, with central bankers and politicians acting in unison to ensure stability. From taxpayer-funded bailouts of major banks to coordinated monetary easing on both sides of the Atlantic, it seemed that the crisis had paved the way for a constructive dialogue that could not only address the pressing issues but also provide the basis for a new way of working together to mitigate systemic failings in financial markets.
It is in this light that the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US and Sir John Vickers' Independent Commision on Banking report for the UK ought to be seen. These were regulatory moves designed to address some of the key vulnerabilities in the banking system that the crisis had laid bare. Their aim is perhaps best summed up in the foreword to Dodd-Frank:
"To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘‘too big to fail'', to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes."
Of course even the noblest of aims are no guarantor of effective legislation but the direction was at least made clear. In effect policymakers were sending a message that it no longer acceptable for banks to enjoy an implicit taxpayer guarantee for risky behaviour.
So what has happened since?
Four years on and the financial sector has recaptured some of its old swagger. A number of those same individuals who had decried the excesses of their industry decided it was high time for the mea culpas to stop.
Far from championing the regulatory measures designed to protect the public from the consequences of financial speculation going awry, the reforms have been re-characterised as a "liberal legislative bonanza".
Yet if politicians have been forced onto the back-foot it is a result of their own timidity in enacting what had been viewed as necessary correctives to the auld orthodoxy.
Though some of this reflects a resurgence of bitter partisanship between left and right, at least a part of this must surely be psychological. When faced with the uncertainty of change it becomes tempting to retreat into the familiar, even if the risks of doing so make appear objectively greater.
This type of behaviour reflects a well established status quo bias in our decision making. William Samuelson and Richard Zeckhauser produced a detailed study on the subject in the Journal of Risk and Uncertainty. They conclude that the bias towards sticking with the status quo could have profound implications, in particular explaining "the difficulty of changing public policy".
Pertinently, they quote Max Planck writing in his autobiography that "a new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it." The same appears true of economics – reaching the brink may have shattered the foundations but people are still happy to play in the ruins.
Searching for Saviours
Out of an understandable sense of frustration a number of well-known economists have used their public platforms to attack the timidity of governments. Of these, perhaps the best known examples are Paul Krugman, Nobel prize-winning economist and New York Times columnist, and Joseph Stiglitz, a fellow Nobel laureate and economics professor at Colombia University.
Indeed Jacob Hacker and Paul Pierson, writing in the New York Review of Books, devoted over 4000 words to lavishing praise on the two men. In a passage that will surely adorn later editions of the book they write:
"Yet Washington is stuck in neutral. Worse than neutral; it is in reverse…Against this backdrop, no book could be more timely than Paul Krugman's End This Depression Now!"
Undoubtedly figures such as Krugman and Stiglitz have added significantly to the broader debate. Yet in the frustration of glacial reform journalists should be wary of raising a narrow set of individuals too high.
The ivory tower that protected Chicago School economists from criticism can just as easily be rebuilt around Keynesians, with the same potential for groupthink. In fact there are a number of economists, not least Steve Keen, who have taken issue with the New Keynesian analysis.
Noah Smith, author of the Noahpinion blog, wrote in a post last week:
"I find Keen's rant completely unacceptable. And not just because it's uncivil, rude, and largely free of substantive content. No, the reason I find it unacceptable is that this sort of ideological purge is the kind of thing that loses revolutions."
While I understand his caution, I respectfully disagree with the conclusion. In this most crucial of debates ideological sides should not become entrenched and participants need not overlook intellectual disagreements with comrades for some idea of the greater good.
Breaking bad habits requires a great deal of heated discussion, and not a few casualties along the way. Krugman, Delong, Stiglitz et al should not be above engaging with them.
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