What lessons should we learn from the financial crises and subsequent economic malaise in high-income countries? These are not merely academic questions. They affect everybody. They are the questions I address in my new book, The Shifts and the Shocks, reviewed at length in the September issue of Prospect by the Harvard economist Kenneth Rogoff.
That essay is an important contribution to this debate, partly because it comes from one of the few academics whose research had suggested the possibility of such a crisis. In his masterpiece, This Time is Different, co-authored with Carmen Reinhart, now also at Harvard, Rogoff demonstrated the recurrence of fiscal and banking crises across the centuries. The review is also important because it highlights important areas of agreement and disagreement.
As Rogoff emphasises, my book attempts to place the origins of the crisis in the workings of the global economy. These include the entry of emerging economies, particularly China; soaring macroeconomic imbalances; and growing inequality. These underlying economic forces interacted with financial liberalisation to create the conditions for the crisis. We agree on this. We agree, too, that we need radical reforms.
Nevertheless, the review emphasises three areas of disagreement.
The first is where, in Rogoff’s view, “Wolf undercuts his important ideas on the need for radical reform by waffling on whether saving Lehman would have solved most of the problem.” On this topic, our differences are small. In the course of 2007, 2008 and 2009, there was a financial panic, which grew far larger after the failure of the United States financial firm Lehman Brothers on 15th September 2008. Asset prices fell dramatically, but then recouped most of their losses. According to Rogoff, in admitting this, I am arguing that if Lehman Brothers had not been allowed to fail, the financial crisis would have been far less acute. But, as he puts it, “if one really believes this, then why take all the risks of a radical change?”
I disagree. The costs of panics, which are real, strengthen the case for radical reforms, rather than weaken it. The memoir of Tim Geithner, the former US Treasury Secretary, suggests that he believes stopping the panic is the heart of what needs to be done. This is not so. Crises do often mark the end of unsustainable trends in credit and…