1998 and 2008: What's Different?
Let me ask Paul two related questions:
Paul, you wrote the first version book a decade ago, back when you were worried that the East Asian financial crisis of 1997-8 was a dying canary in a coal mine, a reflection not of faults in the Asian model but rather a sign that the old business cycle malady that we thought was controlled by monetarist eurythromycin was gaining immunity. But the East Asian financial crisis of 1997-1998--although sharp--was quickly cured (i) once the International Monetary Fund realized that the crisis was not one to be cured by administering painful medicine to governments, (ii) once the U.S. Treasury was freed from the fetters that Alfonse D'Amato and Bob Dole had imposed on it, (iii) once the IMF and the U.S. Treasury understood that their role was that of a lender-of-last-resort, and (iv) once Bob Rubin had bailed the big New York banks into Korea. The old monetarist eurythromycin seemed to work pretty well.
So, first, why did you back in 1998 think that the business cycle malady had developed some immunity?
And, second, why now does it seem as though the business cycle malady has developed some immunity?
Professor DeLong. Isn't that a bit like asking:
"What was your book about,in thirty words or less"?
December 15, 2008 4:44 PM | Reply | Permalink
The misjudgment seems to have been to place too much faith in market mechanisms while ignoring our lack of true understanding of the way in which unfettered markets spread contaminate each other quickly. The current chaos emerged from an unregulated part of our real estate market. The problem was made worse by a series of interconnected institutional failures all of which were caused by lax oversight [e.g. lack of rating agency independence; lack of understanding of the risk profile of assets etc]. Finally policy level responses were made initially on the basis of free market based economic theories where the expectation of rational behavior trumped the memory of recent past experience.
Perhaps we don't understand markets as well as we should. Or, more likely, markets are simply not as efficient as we think they are.
A blind faith in markets too easily allows economists to ignore the other structures and sources of 'disease', and allows them to presume to understand what is going on when, in fact, they are only studying part of the larger problem.
This is why I think we didn't learn from the Asian crisis: our theoreticians have mastered only a small part of the puzzle, while claiming to have a complete understanding of market forces. Our politicians and business leaders executed on the basis of a partial theory!
December 15, 2008 5:28 PM | Reply | Permalink
This is a good comment, and I agree. Market efficiency requires unfettered access to acurate information -- neither of which exists when a large part of the market is driven by a shadow banking system and inscrutable investment instruments.
If we are to prevent this from happening again, then we need to relearn the lessons of the Depression and return to a highly regulated financial system comprised of easily understandable investment vehicles and transactions.
December 16, 2008 10:41 AM | Reply | Permalink
Or to ask DeLong's question differently --
Why is a solution to an export demand destruction problem being experienced by a country "enjoying" a huge current account surplus (an exporter) -- for example, the United States entering the '30s or China, today -- the appropriate solution for a country with a huge current account deficit (an importer) like the United States, today?
December 15, 2008 5:49 PM | Reply | Permalink