Daron Acemoglu on the Financial Crisis
Feb 9 2009

Daron Acemoglu, of MIT, talks with EconTalk host Russ Roberts about the financial crisis and the lessons that need to be learned from the crisis. He argues that economists overestimated the stability of self-interest and ignored the institutional context of financial decision-making. He makes the case for new regulation and worries that political decisions will neglect the importance of growth.

Daron Acemoglu on Inequality and the Financial Crisis
Daron Acemoglu of MIT talks with EconTalk host Russ Roberts about the role income inequality may have played in creating the financial crisis. Raghuram Rajan in his book, Fault Lines, argues that growing income inequality in the last part of...
Arnold Kling on Credit Default Swaps, Counterparty Risk, and the Political Economy of Financial Regulation
Arnold Kling of EconLog talks with EconTalk host Russ Roberts about the role of credit default swaps and counterparty risks in the current financial mess. The conversation opens with the logistics of credit default swaps and counterparty risks and moves...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Feb 9 2009 at 10:54am


I love the podcasts. I had an off-topic question: How come you didn’t sign the Cato Institue Ad in the NY Times against Obama’s Keynesian stimulus plan? Others at George Mason, including Boudreaux and Walter Williams, signed it.


Greg Ransom
Feb 9 2009 at 3:23pm

Great podcast.

Bet yet? Maybe.

Feb 9 2009 at 3:40pm


Thanks for your recent series of perspectives on our current situation. I’m a big fan who just finished working my way through the archives and wanted to point out that Michael Lewis (who wrote “Moneyball” and “Blindside” and gave a great Econtalk podcast a while back), has an article on how the finance industry got so out of whack, and how a few smart people made money betting it couldn’t last, just as Hayek would have predicted.

Lewis’ article is at

Please consider having Mr. Lewis on again to go into more detail regarding his perspective (and that of his contacts from his “Liars Poker” days) on the current economic situation.


Feb 9 2009 at 3:52pm

It appears that the streaming audio hangs at the location, 20:47. I’ve never had technical issues with live streams in the past: probably on the server side. Have you had other complaints?



Lauren (Econlib Editor)
Feb 9 2009 at 4:35pm

Hi, Chris.

We haven’t had any other complaints, and I’ve just listened to the audio using the Play button and had no problem around that time mark.

Sometimes we do get so many people downloading at once, particularly on Monday afternoons, that the servers get stressed. We apologize for the inconvenience.

If you continue to have problems with it, try deleting the downloaded file and then try again. Feel free to email me at webmaster@econlib.org if the problem continues.

Feb 9 2009 at 11:28pm

Hi Russ,

Another great podcast with a wonderful economist, the long list of nobels and clark medals you are racking up hour conversations with is one of the most precious economic treasures on the internet. As a young person it is extremely exciting having access not just to the knowledge and insight of leading economists, but also to their personality and manner.

I do want to pick apart one thing though. The legacy of LTCM. It’s not at all clear it is coherent to call it a “bailout,” especially not in comparison to what the term references in today’s time. The government provided more or less a room and a rolodex and possibly some information. No government money was used in the LTCM bailout. Perhaps, you would argue that some sort of implicit coercion was used, but you must acknowledge that Bear Stearns, the i-bank with the least interest in LTCM was in the room and passed.

The “bailout” seems much closer to a controlled bankruptcy with bridge financing. The bankers put up 3.7 billion to buy 90% of LTCM and sell off its assets over time in an orderly manner rather than at “fire sale” prices. The banks were acting in there own self interest, since LTCM owed most of them money and since a liquidation of LTCM might have caused them to take large losses in their own trading desks. In the end the banks made a small profit.

It seems hard to spin this as a government failure. The government got people together and possibly shared some info with them. They only expanded their choice set. How could that have made them worse off? Would you argue that things would have been better if the group had been unable to follow their own self-interest and coordinate to buy assets? Was their something anti-competitive about combining resources?

It is strange that Wall Street did not learn more lessons from LTCM. And we must try to draw insight from that, but it would be very strange to hear Russ Roberts argue that the Fed should have done the opposite and discouraged any buyout so that the market would have had to take its medicine. Buffet offered a bid that LTCM rejected (it was incoherent, the details were wrong, basically buying the wrong company), should the Fed have tried to hinder such a deal to send disciplinary shock waves through the market?

It seems incoherent to say the government bailed out LTCM and now look what has happened. Perhaps, you have a more nuanced point that I am missing, I’d like to hear it.

I want to close by saying that I am thinking about many of the same things you are thinking about. I thought the analogy of “rock in the river” that you said with Cochrane was useful, I thought the “I’m amazed people lost so much” in this podcast was useful. It is important that as economists who tend to think of markets as robust, to seriously grapple with why they ended up not to be robust in this case. I am certainly not ruling out government failure, but we should demand a certain type of government failure story that is not just ex post analyzing.

Your humble listener,

Feb 10 2009 at 9:33am


I guess I’m breaking with the opinions in the other comments, but I found this podcast lacking. It may be more of a style issue, but I thought there wasn’t a good flow to the discussion, especially the first 30 minutes or so. Granted, the material you covered was rather detailed and dense.

That being said, I did like your give-and-take discussion on regulation. I was left wondering what safeguards Mr. Acemoglu would have in place to limit regulation to ensuring maximum information availability, and not expanding beyond that point.

Stefan Pitschner
Feb 10 2009 at 1:11pm


Just a quick note:The idea of a scrapping-bonus for old cars that you talk about in this podcast has already been implemented in Germany. It is actually a part of the second German stimulus package…


P.S. Thanks for providing the Econtalk podcasts. They have really increased my utility level on an average monday!

Feb 10 2009 at 4:52pm

I placed this in the Austrian Business Cycle comments rather late but I think it applies here as well:

“One problem I have with the idea that outside ‘distortions’ of the market create the boom and bust cycle is that without the boom and bust cycle theoretically markets would follow a steadier growth pattern pattern. If markets began following a steadier growth pattern they would become ‘safer.’ If they become safer people are able to create better systems to exploit the more predictable markets. If people create better systems to make money ‘safely’ profits begin to exceed production which creates a bubble. Am I wrong?”

Interested in people’s thoughts.

Feb 10 2009 at 4:57pm

Daron Acemoglu kept referring to the need for “smarter regulation”. But don’t we always get “smarter regulation” until they fail and replaced with err “smarter regulation”.

The rating agencies are an apt example as they are the creation of regulation and I’m sure everyone was very sure they were being very smart in creating them.

To disagree with Russ, I think people did accept the agency ratings as gospel. In the UK today, the Treasury Select Committee interviewed the CEOs and Chairmans of the bankrupt RBS and HBOS it was clear they had no clue that their AAA rated assets were risky.

Feb 10 2009 at 9:27pm

Fascinating podcast. I was a amused toward the end of the interview when Acemoglu said that he was reassured because Obama had a lot of smart economists around him. At thre risk of being trite, the proof is in the pudding. That is, what is the quality of the economic policies the Obama administration is trying to enact? Which is more important, the IQ’s of his advisors and the institutions where they got their degrees, or whether their actions lead to good or bad outcomes? Russ asked that question, very politely, and it goes to the heart of the matter.

Feb 11 2009 at 5:47am

Russ’s comment that he was ‘Struck by how many people lost in the latest debacle’ may be the result of assuming the actors are ‘economically rational’ in that they are wealth maximisers… perhaps they are simply score keeping, trying to outscore their ‘peers’ in terms of size of bonus, appearances in media, power plays etc. etc. Compare and contrast the ‘BSD’s’ in Wall Street with Warren Buffet in terms of lifestyle and persona. THEN look their economic behaviour. Standing on the shore waving to the Titanic and muttering ‘It’ll never stay afloat’ is much less fun than sitting at the captains table with the other revellers!

John Thurow
Feb 11 2009 at 6:22am

A great follow up to this conversation would be to interview Phillip K. Howard who wrote the book “The Death of Common Sense” essentially a book on the effects of government regulation. His website is: http://commongood.org

Feb 11 2009 at 10:00pm

Always interesting.

This is not a criticism of our erudite host. It’s always easy for Monday morning quarterbacks to think of better replies while listening leisurely to a conversation.

That said, I found the FDA analogy particularly unhelpful and misleading.

The guest had a tendency to conflate deceptively similar but importantly different concepts at several points. Russ did a nice job in pointing out the difference between classical liberal democracy (natural right, republican government, private property protection) and bureaucratic regulation. There may be gray areas here, but they are not identical examples of “institutions” and “regulation.” A partisan may in fact argue that the difference between these two is not a continuum at all, but represents an undesirable “progressive” transformation from self-government to “the administration of things.”

The primary topic (banking in a broad sense) is a fundamental component of capitalism. The pharmaceutical industry, in contrast, is just that – a particular industry with its own specific set of narrow issues that are directly related to the nature of pharmaceuticals. The institutional rules and regulations and administrative agencies, etc. that govern the two have as little in common as the industries themselves and drawing direct parallels between them obfuscates rather than clarifies in this listener’s humble opinion.

Mark K
Feb 11 2009 at 10:12pm

The topics in this podcast touch on many of the subjects my colleagues and I have discussed over the last few years and in particular over recent months. First, I have often commented during our discussions that the incentives present in the modern day stock market are perverse, primarily owing to the vast rewards available to Wall Street investors (bankers, insurance peddlers and buyers, pick your name) if they ‘encourage’ the inflation or deflation of the value of Securities they hold. Such schemes, such as Pump-and-Dump, may not be technically illegal if a fine line is not crossed, yet the moral implications are huge. Of course, chasing short term stock profits, which is often the goal of CEOs, is counterproductive to the true benefits of Finance Capitalism, which beside shareholder profits include overall economic health due to long-term growth of goods and services. This growth is a result of employing stock sale revenue to gain competitive advantage from research and development, new production equipment, better skilled labor, or improved technology. When company stock and option holders can make millions, tens of millions, or even billions of dollars in a year or two, the long-term consequences can become insignificant to them. Once they have made their stash, what does it matter if the company collapses in the long-run? The benefactors of short-term schemes are often long gone and playing golf at the resort of their choice, while the taxpayer (or small-time institutional investor, e.g. 401K) is left holding the empty bag because he was the last one to the party.

Simply more regulation is not the whole answer, although that will be necessary in the case of new financial instruments such as CDS instruments – after all they are really insurance without any capital reserve requirement. Claw-back provisions would also be prudent, as they would discourage chasing unwarranted short-term stock gains in favor of long-term company growth. Enforcement of existing laws is probably more important, and was glaringly lacking in the last 28 years. The SEC has become a joke, as evidenced by the fact that they were tipped off by an independent watch-dog more than 35 times over 10 years about Madoff’s Ponzi scheme, yet they refused to investigate. As Adam Smith noted, self-interested parties pursuing wealth leads to a symphony of economic activity, but in my opinion the players need to know the rules AND observe the adverse consequences for violating them, or the symphony will turn into a Jack Benny solo.

Feb 12 2009 at 3:02am

Sigh, and we dance the regulatory dance again. Let me paint an analogy. A guy is cooking his supper and burns his hand on the stove. Idiot family members come out of the living room, screaming “Regulation! We need to tie oven mitts on his hands so tight that he can never take them off. That way, he’ll never burn his hands again.” You’re sitting there going, “What the hell are you talking about? I think he’s learned his lesson. He won’t be able to do anything else if you tie oven mitts on his hands.” Acemoglu comes along, trying to play the wise man but aware of where the political winds are blowing. He says, “I agree that we need to regulate…” but never quite pins down what that regulation should be. Finally, after lots of hemming and hawing and agreeing with both sides, he says he wants a warning sticker pasted to the stove saying “HOT! Do not touch!” I suppose that, as regulation goes, such informational regulation is as light as it gets and we should be glad he’s not asking for more. On the other hand, you wonder if he’s making the exact same recommendation in his talks with the family members.

In a sense, growth is becoming the new orthodoxy, which is certainly a big step up from the previous dogmas, but one would hope that we could speed these people through all the Hayekian insights, rather than having to feed it to them piecemeal over the decades.

Andy Phillips
Feb 12 2009 at 9:18am

Roberts’ evident inclination to let the ratings agencies off the hook on the grounds that no one believed them is interesting. Does he have a friend in the rating biz? Anyway, the fact that institutions are still required to hold only AAA rated instruments when the ratings have been revealed to be bogus is bizarre. At the very least no rating should be given official credence unless it is accompanied by substantial exposure to downside risk. How to do this, I’m not sure. But continuing to give undue, government-enhanced, economic value to riskless garbage opinion is nuts.

Feb 13 2009 at 11:12pm


Could you consider a guest to discuss input output models. Seems that many economists use these models without consideration of the investment alternative bypassed to redirect to the new public spending.

Many economist are like lawyers in that they advocate for their clients without regard for considering downside risks.

It is also amazing how when this puffery is put out that there are very few economist that challenge economic populists with economic realities. I acknowledge that truth is never absolute, but lack of challenge degrades the value of the economic profession.

Feb 14 2009 at 9:56am


for me the interesting question is not whether or not the stimulus package will distort the economy and delay recovery, of course it will. The interesting question is whether it will help avoid a Great Depression, as Daron suggested. How about a podcast on this topic?

Kim R.
Feb 14 2009 at 11:30pm

Hi Russ,

Listening to your podcasts with your guests is always one of the highlights of my week. With regard to this subject of the financial crisis, I wanted to ask a question that I was hoping you could address.

I have heard Thomas Sowell in some recent radio interviews about the stimulus bill talk about how this bill has the potential to create inflation. As much as I try to educate myself about economics, I thought that inflation was purely a monetary event and not a fiscal one. Is Dr. Sowell saying that the stimulus bill itself will cause inflation, or is he suggesting that the federal government will have such a hard time paying for it that the temptation to fund it through the printing of money will be too great?


Feb 15 2009 at 5:53am

Russ, thanks so much for your work with these podcasts.

Kim – I’m also still just trying to keep my head around things (despite having an Econ major!) but if I recall correctly, fiscal policy should only be inflationary if there is full resource utilization. Could be wrong though 🙂


william davis
Feb 15 2009 at 12:34pm

I wish to also be on record as complimenting Profs Roberts and Acemoglu for their contributions by way of this Econ Talk podcast. I plan to assign this to my Econ Honors Colloquium as an example of an intellectually honest and enlightening exchange on the current problems and how the study of economics can inform the discourse on those problems.

Rob Sternowski
Feb 16 2009 at 8:07am

I’m not sure if I followed your arguments, although it may be from personal bias. In a previous podcast, you presented arguments that cities (such as my hometown of Cedar Rapids, Iowa) that are wiped out by floods or natural disasters should face the cost of recovery on their own. Essentially, the cost of risk should be built into the cost of insurance and initial purchase price, among others. How is the stock and bond market different and why does it need any type of bailout? The only difference that I can see is that one disaster is considered an “act of god” while the other is “manmade”. The cost of risk is built into mortgage-backed securities just as much as it was built into the real estate values of the 500-year flood plain of the Cedar River.

Personal bias aside, it was a very entertaining dialogue.

Ray Mangum
Feb 17 2009 at 6:19pm

“Political power is not a divisible object.” That is a wonderful quote. Almost as wonderful as Juvenal’s “Quis custodiet ipsos custodes”, or “who will guard the guardians themselves?” This is of course the question concerning regulatory agencies. Insofar as the regulators are backed up by a monopoly on force, that indivisible object, the ability to guard them is very weak indeed.

Great show, Russ.

Paul S
Feb 25 2009 at 7:42am

I have a (likely naive) question. When “bailing out” an industry, you can funnel cash to the failing companies or to the strong companies.

Governments seems to strongly prefer investing in the losers – reinforcing moral hazard issues. I can see clear political reasons for doing this: “The government let me keep my home!” “The government saved my job!” But is this method logically/empirically superior to providing capital to the strong companies and greatly facilitating them buying up the worthwhile assets of the failing companies?

Comments are closed.


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Podcast Episode Highlights
0:36Intro. Essay, eloquent and incisive and short. Quote: "Opportunity for us.... Belief that era of aggregate volatility had come to an end." What have we learned about volatility? A lot has been written on Great Moderation, name used to describe decline in business cycle volatility in United States from mid-1970s until the recent crisis. Remarkable decline in aggregate volatility. In 19th century, highly volatile; same for early 20th century; for a lesser degree in first 20 years after post-war era. Same to fairly large extent in other large developed economists. Thinking is that either because we learned the craft of monetary policy or because new technologies have changed the way that firms are able to respond to demand changes or supply opportunities. Is the argument a softening of creative destruction? Labor and capital markets are so dynamic because resources can move around more effectively. Finance is more available, resources can more easily go from declining firms or sectors without creating much unemployment or delay to those with better opportunities. Knowing that the financial sector is better able to diversify idiosyncratic risks, firms are able to be bolder and take more risks and thus be able to exploit their comparative advantages. Better allocation of resources. All true, but wouldn't call it a softening of creative destruction, as Schumpeter envisioned it, but destructive effects are not being felt as strongly in the aggregate economy. One other aspect: Wal-mart effect. One of the firms that epitomizes the effective use of information technology in inventory control and supply chain and thus able to respond to shocks much better. Probably true that monetary policy has become much wiser. Emphasis that emerged that aggregate volatility was a non-issue was nevertheless the wrong lesson to draw.
9:43Develop the argument for that. Nothing in social life, including the economic sphere, is independent of human agency. Variety of subtle complications arise. We are good at abstracting away from the complications. As we recognize complications that played a more important role than we thought, we go back and put them in the model. Create a web of counter-party relations. Example: I have some idiosyncratic risks and want to share them with you. Have to engage in financial trade, implicit or explicit trade: I will pay you some money if my shock is good and yours is bad, and vice versa. Write similar implicit contract with other firms or agents. Web of contracts enable diversification. Role of technology: incredible reduction of transactions costs, allowing the parties to create this web of contracts. Two pillars indispensible for this development. One is technological developments that made relatively rapid communications feasible, accounting, integrated world economy so risks could be shared across regions that are less correlated in demand and production events. Second: financial innovations. Counterparty relations that this process involved causes new risks that were not encountered before and that were not appreciated. Didn't pay enough attention to the fact that this financial system involved a lot of IOUs, and because of its web-like structure, if one set of IOUs failed, it would make the next set of IOUs essentially impossible to execute. Domino effect. What we've done well is diversified a lot of regular risks but in the process created a lot of fragility of the system to real tail events that involve a nontrivial fraction of linked parties failing. Challenge: Great Moderation. In the run-up to the recent crisis, monetary policy did not follow the same pattern that it had been doing in previous 20-25 years. John Taylor podcast, Taylor rule. Alan Greenspan took interest rates to historic lows, 2003-2004. One could argue that had he not done that, all of these problems would have been small or less dramatic. So the fact that the Great Moderation is over doesn't necessarily disprove that monetary policy had worked well over the prior period when it seemed to be working so well because Greenspan went wildly out of the range of policy. Add one thought: monetary policy by setting interest rates has ability to create movements around natural output level. Then monetary policy cannot be decoupled from our beliefs about the state of the economy. At the time people hailed Greenspan's policy, believing volatility had gone away and we could guide economy. If we'd been afraid of crisis, Greenspan would have not used monetary policy in the same way, more hesitant, worried about the run-up in housing prices. Hubris, way too much confidence in our ability to steer the economy. Would have said: "We're gonna fix this later."
20:47Quote: "Our second too-quickly accepted notion is that capitalist economy lives.... Mistakenly equated free markets with unregulated markets.... Greed is neither good nor bad in the abstract...." Corruption part and rent-seeking part of that. Implying that financial markets are unregulated--though some are and some aren't. Agents involved exploited either through asymmetric information or access to regulatory structure. Struck by how many people lost in the latest debacle. Didn't exploit others. How much did the people who were in central positions in the financial markets really lose? Difficult question, don't have the data; also depends on relative vs. absolute losses. Long-term Capital Management crisis (LTCM), warm-up for current bailout, same problems: LTCM had very large positions in a variety of markets; smart but risky events did not work out; Fed of NY and Federal Reserve bailed out LTCM. LTCM partners, Meriwether, lost a large fraction of their wealth. If losing relatively, punished. We think to reward the agent if things go well and punish if things go wrong. Doesn't mean reward him 10% of his rewards when things go well. Almost all major players still went home millionaires. Same for Lehman Brothers. Nugget in yesterday's newspapers: companies paid over $20 billion in non-stock bonuses. Footnote: Head of Bear Stearns, at one point worth $120 million; lost $110 million but did end up with $10 million. Could argue he should have been wiped out; many of his investors were wiped out. Have to add reputational damage. Life isn't so good. Bernie Madoff is the exception. Meriwether ousted, LTCM his brainchild; lost 90% of his wealth but then went to the next hedge fund, extremely respected in the profession. Madoff case blatantly criminal.
30:06Usually we rely on feedback loops of reward and punishment that induce prudent risk-taking--and prudent greed. We've now decided we can't allow the full pain to be absorbed; too messy and costly to allow these risks to unravel. All the lesson has been lost. If government hadn't bailed out Bear Stearns, etc., investors would have learned a lesson, and institutions could have responded. That feedback has been lost. That's where the regulation comes in. First: the really great success of the American economy over past 200 years and many European economies has been that they have been able to use self-interest in the right way, the way Adam Smith envisaged in the Wealth of Nations, bringing progress, economic growth, etc. Suharto, head of Indonesia, in history books as extremely corrupt dictator who filled his and his family's pockets and created economic problems in Indonesia, reduced economic growth. Aren't there people like Suharto in the United States? In the U.S. they can't do that, checked by institutional and social controls. Regulation and institutional checks are part and parcel of our lives and are important in fostering the kind of economic success we have experienced. Put that perspective into the financial sector, where great degree of sophistication is required. Almost impossible for small investors to do these things; have to put some degree of trust in these people. Don't want the government to meddle, but the examples of LTCM means it is very difficult for the market to do that. Going to take away all the earnings of companies that took part in risky earnings? Reduce their wealth but will still leave a lot of incentives for people to actually take gambles. We're not going to torture them or put them in jail. Those incentives are always going to be there. Need something that plays the same role as in the political sphere.
37:36Challenge. List of people prone to corruptions doesn't include governors--oversight. [Taping end of Jan. 2009, Jan. 30.] IL just voted to remove governor. Institutions includes cultural norms, political structure, important because people like Suharto can use force, so need checks and balances of Constitutional system to restrain that power. On regulatory side, central authorities try to steer, they are subject to political pressure; obsessed with creating a risk-free world. Extremely complex web of regulations; and do not well understand their interactions. A set of economic activity tends to get pushed out into non-regulated areas. As a result, our ability to constrain opportunism is impossible. Do we learn that we need to be more vigilant because markets can't do it, or do we learn the opposite: government regulation can never perfectly remove risk and maybe it would be better to let investors be more aware of how risky things are. Institutions are broad and we are not necessarily talking about regulation. Regulation comes with a lot of political costs. Issue is that the type of regulation we need though very far from being perfect is not one that is along the lines of the types we've had. Not greater regulation to insulate consumers, but the type that makes consumers aware of the risks they are facing so we can expect them to make more informed choices. Perhaps combined with safety net, ex ante fairness. Credit rating agencies: going in opposite direction. Because the relationship between credit rating agencies and the financial entities they were rating was not regulated appropriately they created the impression that everything was riskless. Subprime mortgages used to create a triple-A rated security. Led to crisis and run-up of distortions. Not more regulation perhaps but smarter regulation. Investors to have the right information.
45:24One more analogy: FDA (Food and Drug Administration), lots of complaints about how it functions, creates a lot of distortions, but we do need it. Would be problematic if nobody made sure that chemical compounds marketed to solve problem A are not creating other side effects that are poisoning you. Impossible to expect ordinary patient to know this. For the drug market, better to tell patients what the risks are; and certain compounds are off the charts, destroy your liver or cause unacceptable side effects. Quick reaction: Great analogy, FDA has made it much easier for some types of innovations to take place but also raised the cost of innovation. Question is not whether we need it or not, or whether it should be private or public. Private system would have its own problems just as public system has its own problems. How do you create this incredibly amorphous thing called "trust"? In the private sector, mechanisms emerge because people want them. They also emerge politically, in which case they crowd out private mechanisms. Question is: which do you like better? For credit agencies, people say they were part of the problem, but maybe people were aware that AAA didn't really mean that. The problem was that these credit agencies were forced to rate things as triple-A. Problem is extremely difficult. Every time you do a regulation, it's going to create a see-saw effect, press on one end and other end pops up. Perfect regulation is impossible, and also second-best regulation is not something you can establish in context. Big part of the credit rating agencies' disaster was related to other types of regulations--you could only hold AAA on your balance sheet in some types of organizations. Dealing with a very complex problem. Great for economists: a lot of things we can think about that can be relevant for the real world. If a private rating agency or private FDA developed and were able to build the trust, that would be great also. Would create some distortions, but that would be less than the government. Wouldn't call that an unregulated system because system like that wouldn't really emerge or persist unless the government said "I don't need to be the rater or do the rating." Not enough to go to Moody's or Standard and Poor--you need several private agencies. That's a form of regulation, and people might complain about it. Doesn't necessarily mean the government has to say you're good and you're not good. Doesn't say how these agencies would emerge.
53:16So far, cause of the crisis and what we might put in place to prevent such a thing in the future. That in economics is "normative"--what would we like the world be like down the road and what can we do to get there. The "positive" side of economics is what is going to be, not would we like it to be like. Political Coase theorem: There are market forces within politics that can lead to efficiency, or is it really the case that these market forces are not sufficiently active. [taping January 30, 2009]. Yesterday in the paper, four things: 1. The Fed is considering altering the terms of mortgages they are holding, allowing the homeowners to pay less in principal; 2. the House has passed out of a committee the possibility to allow judges to go on a case-by-case basis and lower the principal for homeowners; 3. the Senate is considering paying people to trade in their cars so long as the used car is then destroyed--reminiscent of the 1930s, idea being to somehow create demand for cars--even better if you could only own a car for a week; 4. Senate or House is voting in rider on new spending package that all the infrastructure such as steel have to bought from American firms. Tendency in economics to treat political action the same as individual action, as if there is an "us" or a "we," but it's an emergent phenomenon without many feedback loops. Efficiency in government. When there are a few parties that create externalities for each other we can rely on a Coase Theorem so that they are going to work out their differences. Sometimes been used in concept of politics as well. Serious limits in political sphere. They work in the economic sphere based on precise institutional structure that regulates relationships. Saxophone example. Can actually enter into a contract. If it's explicit we need the courts, if it's implicit we need social norms. Same is not true in politics. The person in power at the moment has the right and power to enforce the contract and say what kinds of payments and actions are okay and which will be prevented. Asymmetry exists because political power is non-divisible object. Political deals harder than private economic deals. Theoretical theme. Coase Theorem type of approach will have much less bite in political than in private transactions. In real world issues, this is only one aspect. One other important element is that coordination is a very difficult thing in political transactions. Only from time to time that large number of people will focus on one specific dimension. It may be that everybody knows they will be better off with free trade, but if at a point in time there is a salient issue of protectionism, significant group of vocal people who will benefit from that, doesn't help that others know they will be better off without protectionism. The vocal minority can manage to solve their collective action problem and might get their way. Final issue: a lot of uncertainty for the public and amongst economists about what constitutes good policy. Krugman. Roberts or Becker as counterpart. Can't really expect the population, voters to agree about everything if they can't agree. Future of political economy in the United States? A lot of dangers. Public wants action, uncertain about the right action. Some cheap and wrong solutions. Protectionism, rallying cry, our jobs are going to be saved, terrible policy, wrong kind of policy as adopted in the 1930s. Important political economy risk is that we can over-regulate. Limited amount of regulation we need, smart regulation. Don't want to limit entry. Don't want in the name of jobs create entry barriers that would prevent new and efficient firms from entering. All possible because there are many different ideas that are playing out right now. Other political economy risk: Why backlash against capitalism and free markets? People could say to go to the other extreme. In essay: there is a difference between free markets and unregulated markets. Real dangers, but looking forward: how afraid that they would materialize? At the end of the day, the Obama team at least has good economists on it in terms of IQ and knowledge: Larry Summers, Austen Goolsbee, Christy Romer. Not as if we have delegated economic policy to a bunch of lawyers who know nothing about economics. Disagreement. Anybody who says they know the answer is being a little optimistic.
1:06:12Hubris about stability, being humble in the face of uncertainty. Being smart isn't enough, have to be wise; even being smart and wise aren't enough. Ben Bernanke looked like greatest person alive we could have at the Fed but he is struggling; and buffeted by political situation. Is the Obama team really going to have a say? Growth may very well be the victim of this political system. Not just whether we have good economists but how does the political system interact with them. Bernanke-Paulson plan, parts difficult to justify, pushed into by political concerns; can use all your brilliant economics but at the end of the day a lot of political decisions. Economic growth: overwhelmingly important issue. Severe recession that costs us 3-4 percentage points of GDP is nothing compared to the loss we would incur by sacrificing economic growth. A 1% decline economic growth in the next 20 years would accumulate to 40-50 percent of loss of GDP in 40-50 years. Sacrificing consumption today is not only sacrificing consumption of relatively wealthy people but also unemployment and real poverty, but at the end of the day, want economic growth guarantees stability. New ideas, allocation of productive resources, essence creative destruction. Real danger would be to take actions that in the name of saving 1% of GDP this year we sacrifice 1% growth rate of GDP for extended period of time, which for 30 years would be about 35% lower GDP. That would be a very large price to pay in exchange for trying to smooth a business cycle recession. Prevent a Great Depression, but as soon as we create the insurance policies to prevent that, focus should turn to policies that are not just important for current conditions but do the right thing for the economic growth potential of the economy.