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According to an old proverb, success has many fathers, but failure is an orphan. That proved to be all too true of the 2008-09 Great Recession: In the aftermath, nobody in the policymaking, financial or academic communities stepped forward to accept responsibility for the worst global economic setback in the past 70 years.
It’s unlikely anyone will take credit for the current global market free fall, which, after three days, is clearly not just a correction but an overdue unwinding of years of excess. Whether the damage remains limited to markets or spills over into the general economy remains to be seen, but we could well be on the verge of another global financial crisis.
This despite the fact that the outgoing Federal Reserve chairwoman, Janet Yellen, repeatedly reassured us that we would not see another global economic crisis in her lifetime, while the academic economic community again distinguished itself by its virtual silence as bubbles formed in the market over the past few years. And just last month in Davos, Switzerland, President Trump boasted again that his administration’s policies were leading to the stock market shattering records on a routine basis, while the bankers kept making risky loans as the music played on.
It’s no surprise that sooner or later, the global financial markets would unwind as violently as they now seem to be doing, considering how far they were allowed to get out of line with their underlying values. It was only a matter of time before a market bust was going to occur.
It was not simply that nothing was done to stop global stock market valuations from reaching levels seen only three times in the past hundred years. It was also that government bond yields were allowed to drop to historically low levels, and nothing was done to stop financial institutions from making very risky loans at unusually low interest rates.
One can perhaps partly excuse the world’s major central banks, including the Federal Reserve under Ms. Yellin’s predecessor, Ben Bernanke, for having set in motion our present boom-bust cycle by their policy response to the Great Recession. Major economies relied too heavily on monetary policy to get past it, while refusing to deploy adequate and well-targeted budget stimulus measures.
With the economy then in danger of succumbing to a deflationary spiral and with interest rates having gone as low as possible, the world’s central banks had little option but to buy government bonds on an enormous scale to encourage investors to take on additional risk. At the time, that seemed a price worth paying, even though it came at the risk of distorting financial market prices and creating a global market bubble.
Less easy to excuse was the Fed’s failure last year to remove the low-interest-rate punch bowl when the global economic party was showing clear signs of getting out of hand. With the American economy having reached close to full employment, and with a 25 percent jump in equity prices and 10 percent depreciation in the dollar over the past year, why was the Fed so reluctant to increase rates? A more aggressive monetary policy in 2017 might have brought sense back to the market and reduced the chance that the American economy might overheat and bring inflation in its wake.
It is also difficult to excuse the Trump administration and the Republican-led Congress for providing us with an unfunded tax cut at precisely the wrong time in the economic cycle. With unemployment very low and the economy growing at a healthy clip, the last thing the economy needed was a fiscal stimulus that might stoke fears of inflation and bring the bond vigilantes out of the woodwork.
The academics and bankers also deserve blame for having learned so little from the world’s last boom-bust cycle. Is it too much to ask of academic economists to learn that excessive asset price inflation is not consistent with long-run economic stability — and that their role should be to sound the alarm when bubbles are forming? Is it too much to ask of the financial sector to remember that making reckless loans gets us all into deep trouble when the music eventually stops?
I raise all these questions not as an exercise in finger-pointing but in the hope that over the weeks ahead policymakers, economists and politicians draw the right lessons about how we got into this very difficult economic and financial market situation. Only then will there be some chance that we might escape these boom-bust cycles, which now appear to be occurring on a regular basis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s policy development and review department and the chief emerging market economic strategist at Salomon Smith Barney.
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