Reasons for the Crisis: Message 10/10

x) The day after tomorrow, the world will be different. 

We may be walking towards a world where governments will have a much larger role in all economies;  where financial intermediationwill be a state-controlled "utility";  where "deglobalization" will happen;  where societal preferences for consumption will be subdued;  and where there will be more than one globalreserve currency.  Developing countries will have true autonomy-----they will now have to rely more on their own internal capacity.  And the "new USA" will still count on its fundamental advantages (unparalleled rule of law; inside track in science and technology; growing population; unmatched military) but it will be a more frugal place, and no longer the engine of growth for the rest of the world.

Reasons for the Crisis: Message 9/10

ix) The multilaterals will become bigger before they become fairer.  

Enlarging the financing power of multilaterals, especially the IMF, has been the correct move, and more of it may still be necessary.   This could be complemented with new liquidity and guarantee facilities, especially for the private sector.  Welcome are also the various new or enhanced forums for global policy coordination (like the G20).  But there is no illusion that global governance will change much any time soon because, in any grand bargain, the power of European countries will have to be trimmed, something that is not seen as politically feasible.  

Reasons for the Crisis: Message 8/10

viii) Macroeconomics will move towards growth-targeting. 

Calls for central banks to go beyond inflation targeting are becoming louder.  Those calls range from asking central banks to target credit or asset prices, to plainly asking for targets on short-term aggregate demand or on the so-called "output gap".  Behind this, there is an increasing recognition that the state (not just the central bank) can and ought to target short-term growth.   This is reinforced by two related factors:  financial markets will remain dysfunctional for a while, and fiscal/monetary stimuli have recently been shown to work better when firms are credit constrained.  The question is which institution should be in charge of "growth targeting", and with which tools.   As central banks begin to lend directly to the private sector ("quantitative easing"), in effect they begin to manage a parallel and unlimited fiscal budget.  It is then a matter of time before Congresses lay claim on that budget, and the central banks lose their independence.

Reasons for the Crisis: Message 7/10

vii) Finance will become simpler.  

There is a general recognition that the market cannot keep financial agents in check.  At some point, they become so systemically important that they cannot be allowed to fail and have to be bailed out.  So a regulatory system is necessary.  The question is of whether that system can continue to rely on markets at all.  Basle II is all but dead.  Its focus on single-bank capital adequacy, internal risk models and credit ratings is seen as grossly inadequate to take care of systemic risk, the procyclicality of marking assets to market, or the intrinsic conflict of interests of credit rating agencies.  Technical ideas to fix those problems abound:  creating a "systemic risk tax" not unlike carbon emission taxes;  shifting capital requirements towards the funding structure (rather than the asset structure) of financial intermediaries;  demanding FDA-type of "health certifications" for new financial instruments;  focusing on the vulnerabilities of the "financial network" using the same protocols that govern the internet;  and so on.  But these sound more like attempts to fix the system that failed than to create a new one.  More likely, the financial industry will become a "utility", whereby a single or a few private suppliers get a government license to provide a standardized service at a regulated price and under heavy supervision.  This will make financial innovation more unusual.

Reasons for the Crisis: Message 6/10

vi) The poor will suffer less than the middle-class. 

In developing countries, the main contact point between people and crisis will be the contraction in labor demand (not a sudden change in relative prices or a sudden loss of wealth, as in the past).  This will affect primarily urban formal workers in tradable sectors.  That is, it will affect proportionally more the middle classes. The poor were already credit-, demand- and productivity-constrained.  So the usual mechanisms to cushion the social impact of the crisis may not suffice.   Social assistance may need to be complemented by social insurance.