Needed: A New Paradigm

In the second part of this article from the Wall Street Journal, several of the pundits responsible for the great cataclysm we now find ourselves in, attempt to understand or explain how they went wrong.


“The Great Unravelling,” written by Jon Hilsenrath and Bob Davis, continues:

Part Two

It isn’t just the public rethinking the old model. Among policy makers and leading economists themselves, the desultory results of the past decade and a half have prompted soul-searching and a re-evaluation of some central tenets of what drives prosperity.

“I went back to square one and asked, ‘Where did I miss it and why?’ ” Mr. Greenspan says. He was wrong about his faith that markets on balance acted rationally, he says. “I had presumed that irrational behavior on the whole was essentially random and produced nothing of value.”

Instead, he says, bouts of fear and greed are systematic, leading markets to overshoot and undershoot.

“We’ve all had to get a dose of humility,” says Martin Baily, chairman of President Bill Clinton’s Council of Economic Advisers in 2000 and an attendee at that celebratory White House reception.The economic rethinking under way is far from complete and echoes the re-examination that occurred after the Great Depression. A new army of economists is investigating what went wrong. Their work will shape how the U.S. deals with trade, monetary policy, technology, the workforce and fiscal policy for decades, though their conclusions aren’t always in line with the populism embraced in the political arena.

“I do not believe we can go far wrong if we maintain a consistent, vigilant, noninflationary monetary policy…a trade policy that fosters international competition…and an education policy that ensures all Americans can acquire the skills needed to participate in what may well be the most productive economy ever.”                                                                    —Alan Greenspan, April 2000

Mark Gertler, a New York University economics professor, is rewriting models for central banking and the macroeconomy, filling gaps in how economists thought financial markets and monetary policy affected the economy.

For Fed officials in the early 2000s, an article of faith was that manipulating a single interest rate—an overnight-lending bank rate called the federal-funds rate—could keep the economy on an even keel. Mr. Gertler’s research partner, Princeton professor and future Fed chairman Ben Bernanke, argued central banks helped create a “Great Moderation” of stable growth and low inflation.

The moderation turned out to be a mirage.

“There certainly was a lot of hubris about the ability to stabilize the economy,” says Mr. Gertler.

Mr. Gertler is seeking new ways to account for the risks of financial crises, collapsing banks and other unstable financial institutions. Yet many central-banking dilemmas the last crisis uncovered remain unresolved. Among them: Central bankers aren’t at all sure better regulation, the preferred tool of Mr. Gertler and Mr. Bernanke, can prevent another crisis.

Perhaps most vexing, central banks themselves might spark crises by pushing rates down in a quest for growth. “We’re stuck,” says Raghuram Rajan, the Reserve Bank of India’s governor. “We cannot admit the tools we have are less and less powerful than we predicted and may have perverse effects.”


Central banks can manage the balance between growth and inflation and the fallout from financial bubbles.


The Fed didn’t deliver the growth it expected, consistently undershot its own inflation objective, and missed the buildup of financial excesses which caused the 2007-2009 financial crisis.

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