Crisis economics – the crisis as a challenge for economists

Much has been written on this issue but there is always scope for more.

Dr Jens Weidmann, President of the Deutsche Bundesbank speaks on the topic. He begins comparing econs with seismologists:

On 6 April 2009, a severe earthquake occurred in the central Italian town of L’Aquila with the tragic loss of more than 300 lives. Only six days earlier, there had been a meeting of a national commission for the forecast and prevention of major risks. Afterwards, the experts made a public declaration that, despite a few tremors over the past few days, there was currently no heightened risk of an earthquake in the region.

Ladies and gentlemen, I am telling you about this incident because it is possible to draw instructive parallels with the role played by economists in the crisis. In much the same way as seismologists are accused of not giving ample warning about the possibility of an earthquake, economists are accused of not giving ample warning about the looming financial and debt crisis.

And much as engineers are accused of making buildings that are not earthquake-resistant,economists are accused of building design flaws into the financial and economic system, with whole nations now suffering under the consequences.

Hmm…Seismologists accept their mistakes and flawed models, econs don’t.

In my view, the accusations levelled against economists are, at best, only partly justified, however. Allow me to use the events at L’Aquila again by way of illustration.The global financial crisis has often been described as a “quake on the financial markets”.But that is an unsatisfactory metaphor. And that is because the financial crisis, unlike an earthquake, is not a natural disaster. On the contrary, the crisis is 100% man-made.

Economics is not an exact science: it is a social science. The laws of economics are not laws of nature. Earthquakes can be explained as natural phenomena. When, where and with what force an earthquake strikes cannot be predicted with any accuracy, however. It is nevertheless possible to say in advance which regions are at severe risk from earthquakes
and which are less exposed. 

Certainly, financial stability reviews and other economic studies prior to the crisis contained some hints at shifts in the financial system. BIS, for example, gave repeated warnings about the setback potential stemming from the rapid growth in the credit securitisation and credit derivatives segments. Just to refresh your memory: between 2001 and 2007, the volume of credit default swaps grew by the factor of 100.

He points to three areas where there is a need to rethink:

  • We need an intelligent financial market regulation.
  • We need to keep a closer eye on the stability of the financial system and
  • We need a crisis-proof framework for monetary union.

 

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