What We’ve Learned from the Financial Crisis - Harvard Business Review

What We’ve Learned from the Financial Crisis - Harvard Business Review:

Five years ago the global financial system seemed on the verge of collapse. So did prevailing notions about how the economic and financial worlds are supposed to function.

The basic idea that had governed economic thinking for decades was that markets work. The right price will always find a buyer and a seller, and millions of buyers and sellers are far better than a few government officials at determining the right price. In the summer of 2007, though, the markets for some mortgage securities stopped functioning. Buyers and sellers simply couldn’t agree on price, and this impasse soon spread to other debt markets. Banks began to doubt one another’s solvency. Trust evaporated, and not until governments jumped in, late in 2008, to guarantee that major banks would not fail did the financial markets settle down and begin fitfully to function again.

That intervention seems to have prevented a second Great Depression—although the inhabitants of a few unfortunate countries such as Greece and Spain might beg to differ. But the economic downturn was definitely worse than any other since the Great Depression, and the world economy is still struggling to recover.

And what has been the impact on economic thinking? Seven years after the crash of 1929, John Maynard Keynes published the most influential work to come out of that era of turmoil—The General Theory of Employment, Interest and Money—yet not for at least another decade was it clear how influential that book would be. Five years after the crash of 2008 is still early to be trying to determine its intellectual consequences. Still, one can see signs of change. I’ve been following academic economics and finance as a journalist since the mid-1990s, and I’ve researched academic debates going back much further than that. To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world—the corporation—may be loosening.

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