Crisis encourages a re-examination of economics DG ECFIN 6th Annual Research Conference: Crisis and Reform
The financial crisis and recession have presented a major challenge for policy makers – and for the economics profession. While there has been little disagreement regarding the immediate crisis response, there has been less agreement on the medium- to long-term approach. How will the crisis affect countries’ willingness to implement reforms, such as reforms to improve the design of the financial system? And how will the crisis affect the very paradigms underlying our economic thinking? DG ECFIN’s 6th Annual Research Conference, held on 15-16 October in Brussels, examined these interrelated questions.
The illusion of stability
Axel Leijonhufvud of UCLA opened the conference with a keynote lecture (“Macroeconomics and the crisis: a personal appraisal”) in which he concluded that a modern economy is not globally stable. Leijonhufvud asserted that the instabilities that general equilibrium theories ignore are precisely the problems that macroeconomists should address.
The political economy of reform
How then to deal with these instabilities was the topic of the first conference session: “The political economy of reform”. In his keynote address (“Financial market crisis, financial market reform: Why hasn’t reform followed crisis?”), Allan Drazen of the University of Maryland examined arguments supporting the hypothesis that crises induce reform: (1) crises make people more aware of needed changes; (2) crises make groups willing to forgo private gain while weakening groups that block reform; (3) a deterioration of the status quo makes groups more willing to accept uncertainties associated with large structural changes; and (4) crises weaken powerful interest groups that block reform. Drazen concluded that the empirical evidence of the link between crisis and reform is mixed and that reforms are easier to implementduring times of crisis.
Paul van den Noord of DG ECFIN and his coauthors found that the chances of re-election for an incumbent government are not significantly affected by its record of “pro-market reforms” (“Reforms and re-elections in OECD countries” co-authored by M. Buti, A. Turrini and P. Biroli). But the authors also found that reformist governments tend to be voted out of office in countries with rigid product and labour markets.
Financial sector reform
Reform in practice was the subject of the second conference session: “The design of financial systems”. Charles Goodhart of the London School of Economics started his keynote address (“Banks and the public sector authorities”) with an examination of the limitations of the Anglo- Saxon model. He noted two possible responses: (1) a return to the status quo ante, in which the State would no longer be a general guarantor; and (2) limiting the range of institutions or functions to which the safety net applies (e.g. “Narrow Banking”), but also noted the limitations of each. Fears that narrow banking would create shadow banking were expressed.
Economics under the microscope
The final session of the conference revisited elements of the economic paradigm. In his keynote address on “Top-down versus bottom-up macroeconomics” Paul De Grauwe of the Catholic University of Leuven distinguished between a system in which one or more agents fully understand the system (top-down) and one where no individual understands the whole picture (bottom-up).
The conference ended with a lively panel discussion. Panellists said that the ideal economic model should help policy makers see reality better, that it was time to rethink the role of the financial system in the macro economy and redesign financial institutions, and that taxpayer bailouts and other violations of budget constraints provide fertile ground for extremist political movements. Several panellists also stated that central banks should be responsible for monitoring asset prices and not just for stabilising the consumer price level.