14th Sir Arthur Lewis Memorial Lecture 4 November 2009 Sir Cecil Jacobs Auditorium, ECCB Headquarters St Kitts and Nevis
We didn't believe it before the crisis and we certainly don't believe it today.
Government plays an indispensable role in the development process and its role continues to evolve as the economy advances. There is no one model that dominates, even in advanced economies, since the German corporate model wouldn't work in Brazil, and the British post Thatcher model wouldn't work in India, and the Chinese model only works in China. So what do we expect of governments, especially these days?
First we can expect governments to intervene when markets cease to function well. When fear creates ill-liquidity and panic sales and when the economy is in free fall, governments must act. That was the central admonition of Keynes and it rang true again in 2009 as Paul Krugman wrote in the N.Y. times in September: ” Ben Bernanke understood this well. Pity that his predecessor at the Fed read too much Ayn Rand and not enough Hyman Minsky or else we might have well avoided the catastrophe of 2009 when world output shrank for the first time in 70 years.” So government needs to act in emergencies. Of course they need to act wisely but also quickly.
Governments also need to regulate markets to limit the cost of crises and to protect the average citizen when economic actors take on too much risk and imperil the system. The list of regulatory failures is indeed long, especially in the U.S. but elsewhere as well. Too big to fail has always been a problem, but systemic risks based on excessive leverage in highly inter- connected markets add further peril. Interestingly, less sophisticated financial markets and better regulated markets like that in Canada survived the crisis well.
As Akerlof and Shiller describe in their recent book, Animal Spirits, greed is a driver of economic activity but we need to place limits on the actions of the greedy. The Shiller-case housing index and comparisons of earnings to housing prices should have set off alarm bells but they did not. Charles Calomiris of Columbia University sees politics as well as bad economics as culprits, as everyone pushed increasing home ownership in a world of
unbelievably low interest rates. And here one can say something nice about John Taylor, namely the massive divergence from the Taylor rule in the conduct of US monetary policy bordered on the criminal.
Government needs to exercise regulatory oversight impartially and aggressively, more in the spirit of Singapore than China or the US or the UK.
And finally governments as providers of a level playing field need to be concerned about the fairness of the system.