Oliver Denk, OECD Directorate for Employment, Labour and Social Affairs, and Gabriel Gomes, OECD Economics Department
In a report issued in June 2017, the Trump administration laid out its proposal for overhauling some of the regulations President Obama had enacted with a view to avoiding a financial market meltdown of the kind we saw in 2008. But what do we actually know about how financial regulation has evolved around the world since the global financial crisis?
Bank supervision has certainly been an active area of reform, not only in the US, but in many other countries. The Basel III accord, the new international regulatory framework for banks that is currently being rolled out, is one well-known testimony. Some countries took less well-publicised action to tighten up supervision, not least when oversight existed institutionally but failed to function properly in practice.
Financial policy, however, goes much beyond bank supervision. It also includes aspects such as credit controls, ease of entry into the banking sector, capital account controls and government ownership of banks. The general picture of the 30 years leading up to the crisis was one of liberalisation of domestic and international capital markets, accompanied by efforts to strengthen frameworks for bank supervision. But the various dimensions of financial policy are rarely assessed together, even though they all matter for financial markets, corporations and households.
This is precisely what we have set out to do, as we explain in our new OECD working paper. In fact, we have assembled a novel dataset on financial policies from 2006 to 2015, by building on an index from the International Monetary Fund. The index by the IMF is the most widely used measure of financial reforms in cross-country empirical research, having been used in some 200 publications. The trouble is the IMF dataset was only available up to 2005–so we have effectively extended it by another 10 years. The index has its strength in covering many different types of financial policies, though it is not overly specific on most dimensions.
What do we find? In some areas, financial policy has become less liberalised since the global crisis. Bank privatisation has seen the strongest break in trend. Governments had reduced their ownership in banks over the one to two decades before the crisis. But since then, recapitalisations in a number of countries have increased government ownership and lowered financial liberalisation in this respect, as the chart below shows.
In other areas, financial liberalisation has more or less stayed the same. Take restrictions to international capital movements. By standard measures, these had largely gone in most advanced economies before the crisis. Today, the developed world as a whole is as financially open as 10 years ago. However, some countries such as Chile, Iceland and Slovenia have tightened their capital account restrictions, even if others like Australia, Korea and Turkey have lifted theirs.
Bank supervision efforts continued to strengthen through the 2000s under the Basel accords. In many countries, this has not only changed how capital requirements are set, but also reinforced the way in which supervisory authorities assess prudential reports and statistical returns from banks through on-site and off-site examinations.
On the whole, our data suggest that the financial crisis has not undone the financial liberalisation that was achieved in the preceding three decades or so. However, it remains to be seen whether the renewed state ownership of banks is part of a temporary post-crisis phenomenon or something longer term. Governments do tend to sell off their stakes in banks when they find the opportunity, and a few countries–Austria is a good example–have now unwound their increased ownership in banks, in some cases thanks to liquidation.
Developments have been quite different for emerging market economies, in particular the BRIICS countries*, where financial liberalisation has continued at the same quite rapid pace as before the global crisis. One reason is that entry barriers into the banking sector have been lowered in some cases; other factors include stronger bank supervision and the deregulation of stock markets. Finance nevertheless remains substantially less liberalised in the BRIICS than the OECD, as the graph below demonstrates.
These are just some of the revelations of our new data, which will hopefully allow the many researchers who have been relying on the IMF dataset for quantifying financial policies to delve into an additional 10 years of observations. This is vital for tracking how policy has affected financial systems and the real economy since the crisis. If you are such a researcher and would like to use the dataset, please contact us at any time.
Denk, O. and G. Gomes (2017), “Financial Re-Regulation since the Global Crisis? An Index-Based Assessment”, OECD Economics Department Working Papers, No. 1396, OECD Publishing, Paris
* BRIICS countries are Brazil, Russia, India, Indonesia, China, South Africa.
In The Magic Mountain, Thomas Mann wrote famously that “everything is politics”. There are some who believe that fiscal policy should be a notable exception. Those who share this viewpoint would like to see fiscal policy removed from the political arena and encapsulated in a non-partisan process, along the lines of monetary policy. But, this isn’t likely to happen anytime soon, and for reasons deeply rooted in modern democratic principles. From the First Baron’s War (1215-1217), resulting in the Magna Carta, to the French and American revolutions, the notion of taxation without representation has been roundly repudiated. What works for monetary policy and institutions such as the Fed or the ECB, cannot, it seems, work for fiscal policy.
Why is this even an issue? Because democracies have a hard time not spending more than they take in. The composite fiscal balance of all OECD countries, as well as most of its individual member countries, was in deficit throughout virtually the entire three decades prior to the crisis of 2007/2008 (OECD Economic Outlook 2009). The term for the phenomenon is ‘deficit bias,’- the tendency of democratically elected governments to veer into the fiscal red and stay there. Deficits can be manageable. But when they reach levels that are considered unsustainable, mere bias becomes ‘fiscal irresponsibility’, ‘fiscal profligacy’ or more colorfully, ‘fiscal alcoholism.’
One strategy for curbing deficits consists of fiscal rules. Fiscal rules codify deficit and debt ceilings, providing policy makers with a legal framework to guide better fiscal choices. To work, fiscal rules must navigate a tricky line between being sufficiently comprehensive to accomplish their objectives and anticipate loopholes while avoiding soul-crushing complexity and rigidity. Not an easy task, as critics of the European Union’s Stability and Growth Pact are quick to point out. Fiscal rules must also have the flexibility required to support a country’s broader macroeconomic objectives. To jumpstart growth during a downturn, governments follow countercyclical policies, increasing public spending and providing tax relief when government coffers are at their lowest (apostasy to anti-deficit hardliners). Then, when better times return, the previously avoided tax hikes and spending cuts must be instigated.
Governments consistently get the first part right.
The financial crisis was a “gotcha” moment, catching many countries off-guard and in vulnerable positions. Eight years on, countries that had the highest deficits going into the crisis still have the lion’s share of fiscal consolidation ahead of them (OECD, The State of Public Finances 2015). The public debt position of OECD countries continues to worsen.
Can watchdogs be rescue dogs? The OECD thinks so. The period since the crisis has seen the rise of a relatively new breed of fiscal watchdog-the Independent Fiscal Institution (IFI), also known as Fiscal Councils. Prior to the crisis, only six countries had IFIs in place. Today, they number twenty-five and growing. It could be that IFIs are the missing link in a form of fiscal tri-therapy already consisting of fiscal rules and budget reform. That’s the hope of the OECD and many of its members. The OECD Network of Parliamentary Budget Officers and Independent Fiscal Institutions (PBO network, for short) was created as a support organization for IFIs ranging from fledgling operations to well-established entities.
In many cases, the support is badly needed.
This has a lot to do with the precarious role IFIs play, particularly when starting out. Their job: to depoliticize fiscal policy information, intervening prior to policy but without decision-making authority. If it sounds like a challenge, it is. What IFIs can do is issue objective, non-partisan assessments of proposed fiscal policies, promises and programs. In lieu of legally binding enforcement power, the IFI plays the role of fiscal gadfly, whose job—not unlike that of Socrates—is to point out inconvenient truths that often contradict the powerful and ambitious and the institutions that they represent. We know what happened to Socrates. Needless to say, it can be a lonely job. Effectiveness depends on having good friends elsewhere, notably in the financial community, the media and of course the greater public. It also requires a solid reputation for independence, transparency, expertise and fearlessness. IFIs must be constituted to resist partisan pressure and intimidation in all forms, from the risk of defunding to being shut out from vital government data.
Consequently, every IFI that has made it has a harrowing, near-death experience to recount. For the UK’s Office of Budgetary Responsibility (OBR), it occurred in November, 2011, the day it told the government it could not afford its budget plans (the Chancellor duly revised them). For Canada’s Parliamentary Budget Office it was the publication of its first report—during an election campaign–revealing that the cost of participating in the war in Afghanistan was significantly higher than claimed. One European IFI went from a well-staffed organization with a broad remit, to a vastly reduced operation consisting of just a few people. Venezuela’s Congressional Budget Office was shuttered without further ado by President Hugo Chavez in 2000, two years after its creation.
The OECD’s PBO network offers a place where IFIs can exchange best practices and build up their staying power in a dangerous but badly needed line of work. Following the OECD Recommendation on Principles for Independent Fiscal Institutions, the PBO network offers guidance on setting up and managing effective IFIs.
So, why is deficit bias so entrenched? At least some of it boils down to politics. In campaign mode, the urge to give (funding programs, cutting taxes) is consistently stronger than the urge to take away. When it comes to cold, fiscal reality, there seems to be a strong belief that ineluctable truths make unelectable candidates. Ironically, some research suggests that if voters are made fully aware of fiscal arithmetic, they will support short-term costs for longer-term gains (Alesina et al. 1998, cited in Calmfors and Wren-Lewis, 2011). Also, fiscal processes are complex and chaotic—not a monolithic, well-coordinated activity like the Berlin Philharmonic playing Beethoven, but more like a stadium filled with oom-pah-pah bands, each seeking to be heard above the rest. With well-conceived fiscal rules and objectives, aided by strong and sufficiently supported independent fiscal institutions, policy makers may at last begin to play in the same key when it comes to fiscal responsibility. That, at least, is the outcome that the OECD’s PBO network is passionately working towards.
It’s a big day here today, with French President François Hollande and senior ministers coming to find out what the heads of the OECD, World Bank, IMF, WTO and ILO have to say about the global economic outlook as well as the European and French economies. They’re discussing policies needed to return to growth, redress global imbalances, improve competitiveness and alleviate the social impact of the crisis.
We talked about the OECD’s views here in an article called “Doom and gloom” on the May interim global economic outlook. The main worry was that the euro area crisis is dragging down the rest of the world economy through its impacts on trade and business and consumer confidence. The World Bank agrees. Their Global Economic Prospects says that “resurgence of tensions in the Euro Area is a reminder that the after effects of the 2008/09 crisis have not yet played out fully. Financial market uncertainty and fiscal consolidation associated with the high deficits and debt levels of high-income countries are likely to be recurring sources of volatility for the foreseeable future as it will take years of concerted political and economic effort before debt to GDP levels of the United States, Japan and many Euro Area countries are brought down to sustainable levels.”
The World Bank’s sister organisation, the IMF supports its sibling, and the OECD. The Global Financial Stability Report (GFSR) says that “risks to financial stability have increased since the April 2012 GFSR, as confidence in the global financial system has become very fragile. Although significant new efforts by European policymakers have allayed investors’ biggest fears, the euro area crisis remains the principal source of concern.”
Austerity is among these efforts, but the OECD warned that although this is a medium-term policy designed to help public finances, it acts as a drag on short-term economic activity, and can even start a negative feedback loop whereby activity is weaker than expected when planning the budget, so less tax comes in and there is overspending, and then the need for more consolidation, which acts as a drag…
The ILO calls this the “austerity trap” in the latest World of Work Report, and outlines a similar vicious circle to the one the OECD described: “Austerity has, in fact, resulted in weaker economic growth, increased volatility and a worsening of banks’ balance sheets leading to a further contraction of credit, lower investment and, consequently, more job losses. Ironically, this has adversely affected government budgets, thus increasing the demands for further austerity.”
The ILO estimates that there is still a deficit of around 50 million jobs compared to the pre-crisis situation, and “It is unlikely that the world economy will grow at a sufficient pace over the next couple of years to both close the existing jobs deficit and provide employment for the over 80 million people expected to enter the labour market during this period.”
As you’ve no doubt noticed, there’s a general air of pessimism about these reports, and even the efforts that have been made to address the issues that caused the crisis in the first place don’t generate much enthusiasm. Financial sector reform for instance, leaves a lot to be desired according to the IMF, because although there has been some progress over the past five years, financial systems have not come much closer to being more transparent, less complex, and less leveraged. “They are still overly complex, with strong domestic interbank linkages, and concentrated, with the too-important-to-fail issues unresolved.”
Developing and emerging economies did comparatively better than the more developed economies during the crisis, but even there are worrying signs, with the World bank warning that in a new crisis no developing country would be spared, particularly those with strong reliance on worker remittances, tourism, commodities or those with high levels of short-term debt or medium-term financing requirements. Even without a full-blown crisis, elevated fiscal deficits and debts in high-income countries and their very loose monetary policies mean that the external environment for developing economies is likely to remain characterized by volatile capital flows and heightened investor uncertainty.
But let’s end of a positive note. The WTO’s figures reveal that world merchandise exports increased by 5% in 2011 in volume terms. The United States remains the world’s biggest trader (in value terms), with imports and exports totalling $3,746 billion in 2011. China and Germany rank second and third respectively. Exports of commercial services grew by 11% in value terms. The United States is the world’s largest trader, with $976 billion of services trade in 2011.
See you next year, if President Hollande’s suggestion to make this an annual event is adopted.
Today’s article is from John Hulls, of the Cambiant Project at the Dominican University of California that uses a fluid dynamics modeling concept he developed to simulate economic performance. John is also an affiliate at Lawrence Berkeley National Laboratory, working principally in the area of environmental applications of the LBL Phylochip microarray technology.
A basic capitalist tenet is that the market represents the most efficient way to allocate capital. How well is it working?
We are rapidly evolving a fast-moving, increasingly cybernetically interlinked capital marketplace that, as Lord May observes in the Santa Fe Institute Journal, has become intertwined in ever-more complex interdependent patterns. He goes on to ask how much are we, societally, paying the financial sector to allocate capital? More importantly, is the sector allocating capital to further societal goals, or merely enriching itself and a narrow segment of the world’s population? Human nature is powerful. John Stuart Mills said, in Social Freedom: “Men do not merely desire to be rich, but richer than other men”.
Benjamin Friedman holds, in The Moral Consequences of Economic Growth, that “greater opportunity, tolerance of diversity, social mobility, commitment to fairness and dedication to democracy” derive directly from economic growth. He shows that even during stagnation–let alone recession and depression–those values can vanish easily. Brad Delong observes, in reviewing Friedman, that if the majority of the people do not see an improving future, these values are at risk even in countries where absolute material prosperity remains high. Given rising political intransigence and loss of common social purpose in the U.S., and the rise of nationalistic political sentiments in Europe, the effects of increasing stagnation and inequality are becoming more evident, despite the financial sector’s phenomenal growth.
In a 2006 speech on the growing integration of the financial sector and the broader economy, Rodrigo deRato, Managing Director of the IMF, noted its supposed general stability and growth, and that from 1990-2005 the estimated sum of equity-market capitalization, outstanding total bond issues (sovereign and corporate) and global bank assets rose from 81% to 137% of GDP, while over-the-counter derivatives markets tripled in the latter five years to $285 trillion, six times global GDP, 50 times the U.S. public debt. So if the financial sector has worked, we should see proportional acceleration of growth plus improved consequences for all society.
This is not happening, as Cornia and Court report in Inequality, Growth and Poverty in the Era of Liberalization and Globalization.Global poverty reduction has stalled for 30-40 years, despite an approach to growth based on “…a neo-liberal policy package, [including] stringent focus on macroeconomic stability, liberalization of domestic markets, privatization, market solutions to the provision of public goods, and rapid external trade and financial liberalization.” They reveal that inequality has grown faster during the same period in the majority of countries for which data is available. The paper also shows that increased inequality greatly encumbers the climb from poverty and that excessively low or high levels of inequality impede growth, provoking various ills, including crime, social conflict and uncertain property rights. In the US, bank employees were found to be signing thousands of foreclosure documents without checking the information in them in so-called robo-signings that rendered the documents illegal.
All the data seem to affirm Friedman’s assertion that all societal strata should participate to maximize the moral benefits of economic growth. Further support can be found in Court’s conjecture about an optimum range of equality. This is confirmed by modeling work at Dominican University, discussed in a previous OECD Insights post, which shows that there is indeed an optimum level of equality for a given economic structure useable for policy planning, to insure capital allocation to economic growth for public purposes. Returning us to Lord May’s point that we must know how much economies are ‘paying’ the financial sector to allocate capital, including payments to banks, sovereign funds, hedge funds, private equity, and the managers, often in major international banks, of the estimated $21-32 trillion of largely secret “offshore” financial assets.
The financial crisis and subsequent Euro problems show that we are paying vast sums for a system that, as Joseph Stiglitz, former chief economist of the IMF, points out, doesn’t allocate capital where needed, causing capital flows that are pro-cyclic, exacerbating peaks and lows of business cycles. What efficient capital distributive function is served by the approximately $1.5 trillion of daily flows sloshing about in the casino of OTC foreign exchange activities, and the nearly 70% of all U.S. market trades conducted algorithmically, without human intervention?
Keynes may have lost the 1944 Bretton Woods battle for a solution that transcended national financial self-interest but his plans for an international clearing agency are prophetic, especially considering how the combined financial sector dominates national and international policy for its own ends “ As Keynes said, “… no country can . . . safely allow the flight of funds for political reasons or to evade domestic taxation or in anticipation of the owner turning refugee. Equally, there is no country that can safely receive fugitive funds, which constitute an unwanted import of capital, yet cannot safely be used for fixed investment.” Right again, Lord Maynard.
On September 5th 1661, Louis XIV ordered D’Artagnan and his musketeers to arrest Nicolas Fouquet, the “Surintendant des finances”, for the capital offences of embezzlement and crimes against the state (or Louis XIV as it was known in those days). Fouquet was accused of ruining the king through exorbitant interest rates on sovereign debt as well as diverting some of the financial flows from lenders to the royal coffers into his own pocket.
Fouquet defended himself well though, and after a three-year trial was exiled rather than executed. However today he’s mostly remembered for parties that even the Sun King found a tad extravagant (although Louis did build the Palace of Versailles as a bigger, blingier version of Fouquet’s château at Vaux-le-Vicomte).
There’s a lot of truth in the popular image, but it doesn’t tell the whole story. Fouquet tackled problems that would be familiar to any European finance minister today, using means that are still part of the policy response to the current crisis such as cutting public spending, rescheduling debt and raising taxes and improving their collection. (He also used a few that aren’t so common or so blatant anymore such as selling public offices to his cronies.)
Fouquet understood something that is key to the present crisis: the need to restore confidence and get the economy moving. He did this thanks to a number of instruments including reassigning to solvable funds sovereign debt that had in today’s terms become junk bonds and even providing collateral himself for sovereign borrowing.
So, restore trust, fix the financial system, stimulate growth. Three and a half centuries later, you can read a similar argument in a paper by Adrian Blundell-Wignall, Special Advisor to the OECD Secretary-General on Financial Markets. In Solving the Financial and Sovereign Debt Crisis in Europe, Blundell-Wignall looks at why the crisis is worse in Europe than elsewhere and what can be done.
Monetary union means that euro members can’t devalue their currencies to help exports, and pressures on international competitiveness are transmitted directly to the labour market, leading to increased unemployment. Some governments responded by allowing their deficits to grow, and debt with it. Moreover, monetary union has resulted in high levels of debt in the household and corporate sectors in many of the countries that are in the worst competitive positions, leaving little hope that savings can be spent to stimulate growth.
The crisis and recession have increased indebtedness, contributing to underlying financial instability. One of the main reasons the situation is worse in Europe is the nature of its banking system. European banks mix traditional business such as loans to firms and households with activities in capital markets. Countries with large capital markets banks are heavily exposed to the sovereign debt of larger EU countries like Spain and Italy. Traditionally, holding this dull but dependable debt was a safe form of collateral for other activities, but the sharp price fluctuations that are now typical of sovereign debt trading affects the true value of this collateral and the price that shares in this debt could be sold for at any given time.
Deregulation and innovation in financial markets are to blame too. Apart from capital market banking, “re-hypothecation” has grown massively – the practice of reusing the same collateral repeatedly. This increases risk, given that the value of this collateral can drop suddenly, plus the fact that the banks are doing deals for themselves using collateral originally pledged by clients. As the number of deals using the same collateral multiplies, so does counterparty risk, the risk that one of the parties involved can’t meet their obligations.
Blundell-Wignall argues that underpricing of risk is the core cause of the financial crisis and that excessive risk in banking can always be traced to two basic causes: too much leverage, and for a given leverage, increased dealing in high risk products. Far from acting to contain the risk of the proliferation of these products, such as derivatives, regulators cleared the way for them, for example by removing barriers to mixing different types of banking business such as those in the Glass-Steagall Act in the US.
At one time, derivatives were used for practical day-to-day business operations, such as an airline hedging against a big rise in fuel prices, but they rose from 2.5 times world GDP in 1998 (already a staggering figure) to 12 times world GDP before the crisis.
Derivatives trading needs collateral and the price shifts we mentioned above can result in calls for collateral the banks can’t meet. This provokes a liquidity crisis, and the banks don’t have time to recapitalise through earnings, so they stop lending to businesses, especially small and medium-sized enterprises, adding a further twist to the downwards economic spiral.
It’s easy to feel helpless in the face of such arcane and seemingly uncontrollable forces, but solutions exist. Fracturing the eurozone would be one, but while this may lead to a short-term improvement for certain countries, it would weaken the status of the euro as a global currency, increase pressure on countries that stayed in the euro, and create legal uncertainty about financial contracts in euros.
A more coherent approach would include solving the Greek crisis via a 50% or bigger “haircut” on its sovereign debt (reduction in its stated value) and granting the European Financial Stability Facility a bank license. The European Central Bank should continue to support economic growth and investor confidence via funding for banks and putting a lid on sovereign bond rates in key countries. Private banking should be reformed too, with investment banking separated from traditional retail and commercial banking.
That said, sending musketeers to arrest the financiers would appeal to many people.
Thanks to mass media and social media, awareness of risks (and imagined risks) is growing, while at the same time local difficulties can quickly become global shocks due to the increased physical and virtual mobility of people, concepts and things. But resilience has increased too. For instance, power failures rarely last long in OECD countries because providers have backups and can call on diversified sources. France had to shut or power down 17 nuclear reactors during the 2003 heat wave, but that didn’t deprive any customer of electricity.
But is diversity necessarily a good thing? Cybersecurity for instance is made much more difficult because of the multiplicity of software platforms, infrastructures, telecom networks, norms, and so on that a system depends on. But having only one operating system to attack may not be such a great idea either.
The lonely hacker creating global chaos has yet to materialise, but the fact that what seem like minor problems can now provoke major disruptions reveals an aspect of the risk landscape that will grow in importance: asymmetry. Greece’s GDP is only around $305 billion compared with over $16 trillion for the EU as a whole, but the prospect of a default is causing panic worldwide due to the numerous connections among financial markets that amplify the scale of problems, as we saw with the subprimes crisis. And to stick with finance, the number of traders actually speculating on Greek debt is tiny compared to the power they have.
In addition to asymmetry and amplification, a third “A” is likely to become more important: asynchronicity. This is to be expected as the complexity and number of interactions grow. It could take a number of forms, varying from lags between economic activity and commodity prices to decoupling of countries or regions from swings in the global economy. Asynchronicity complicates the risk landscape because it undermines the case for global solutions to a number of problems.
Why care? And if we do care, what can we do about it, given the scale and intricacy of the problems?
In reply to the first question, the number of people affected by catastrophes is increasing and with it the human and economic costs. Population growth and settlement patterns are putting a growing number of people at risk from natural phenomena such as floods, storms and droughts.
The number of recorded technological disasters such as explosions, fires, and transport accidents has also risen rapidly since the beginning of the 1970s, and economic expansion and competition, combined with greater concentrations of population, will increase the associated risks.
The last major new health catastrophe to appear was HIV/AIDS, but new diseases such as SARS and H1N1 continue to emerge and others are evolving, leading to fears that at some stage a dangerous, new global pandemic is inevitable.
Terrorist attacks remain a constant threat and the world financial system has learned nothing from major crises.
The question as to what we can do is more difficult. The pace seems to be accelerating, but if crises come more quickly, they go more quickly too. The last recession was due to the unravelling of a number of tensions in the system. These tensions were not reduced thanks to any government policy, but built up until they exploded into a systemic shock that plunged the world into a recession and would have destroyed the financial systems if states hadn’t pumped trillions of dollars into the economy. Is pay up and wait for things to improve really the best we can do?
OECD work on risk management in agriculture, arguing that government policies should focus on planning for catastrophic risks like floods and droughts, instead of getting involved in normal farm business risks like price variations.
In October 1929, with storm clouds gathering, economist Irving Fisher warned against blind panic. “There may be a recession in stock prices, but not… a crash” since “Stocks have reached what looks like a permanently high plateau.”
A bit earlier, President Hoover could claim with pride that: “Given a chance to go forward with the policies of the last eight years, we shall soon with the help of God be in sight of the day when poverty will be banished from this nation.”
The working man would be the first to profit, with the US Department of Labor’s New Year’s Forecast promising that “1930 will be a splendid employment year.”
Entrepreneurs were buying their rose-tinted glasses from the same shop as politicians and academics. Thomas Watson, founder of IBM looked forward “with confidence to the progress of business in 1929“.
Then came Black Thursday, October 24th 1929, with the New York Stock Exchange down 11% on opening. Things improved temporarily in later trading, but a whole series of Blackdays lay in store and the stock market crash would soon provoke the worst depression the world had ever known.
It seems astonishing in retrospect that the optimism mentioned above seems to have been crash proof. The Chairman of the Continental Illinois Bank of Chicago stated that “This crash is not going to have much effect on business“. Away from the grubby world of wheeling and dealing, the Harvard Economic Society’s Weekly Letter dated January 18, 1930, agreed. “With the underlying conditions sound, we believe that the recession in general business will be checked shortly and that improvement will set in during the spring months.” The Letter went bankrupt shortly afterwards.
And today? You may remember the bemused question about the latest crisis Queen Elizabeth asked at the London School of Economics in November 2008: “Why did nobody notice it?”
For Professor John Kay of the London Business School and Oxford (and visiting Professor at LSE) one of the reasons is the dominant approach of the profession itself. “If much of the modern research agenda of the economics profession is thus unconnected to the everyday world of business and finance, this is also largely true of what is taught to students [who] could import data on GDP and consumer prices into a statistical package … but would be little better equipped than the person in the street to answer questions such as ‘why were nationalised industries more efficient in France than in Britain?’”
The Institute for New Economic Thinking asked a number of economists to respond to Kay. You can find their replies here.
What do you think? Have the economists and analysts got any better since the Great Depression, or is their main preoccupation explaining why their last forecast was wrong, but we should trust the new one?