Lessons from the Financial Crisis and their Implications for Global Economic Policy

The 2008 global financial crisis was the most traumatic global economic event in three quarters of a century. It followed on a series of crises experienced around the world, including the East Asia crisis, the Mexican crisis, the Russian crisis, and the Latin American crisis. Crises seem to be a part of modern capitalism. Put simply: it is apparent that the post-World War II capitalist system is neither efficient nor stable—and it is increasingly apparent that it is also not equitable, marked as it is with growing inequality. The latter is not a surprise—economic theory never claimed that the distribution of incomes generated by the market would be socially acceptable; but the presumption among Western elites, and many citizens, was that the free market system was efficient and stable. They cited a large body of literature, from Adam Smith on, showing the efficiency of the market. To me, the major lessons of the global financial crisis were that the competitive equilibrium model was discredited, and there is an urgent need to create models and policies based on more realistic analyses of the economy. Had policymakers taken on board the developments in other strands of macro- and monetary economics—already going on before the crisis, but advancing significantly since then—they would have done more to prevent the crisis and would have been in a better position in responding to it. I illustrate this theme by looking at a series of policy positions that were central to macro-management in the years before the crisis. This essay is divided into three sections: In the first, I focus on domestic macro-management; in the second, I focus on macro-management in open economies; and in the third I turn to questions of global governance