Noted for April 10, 2013
Wednesday Hoisted from (Other People's) Archives: Ethics of Macroeconomics Edition

Mark Thoma: Robert Solow on "Has Financialization Gone Too Far?"

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Mark Thoma:

Economist's View: Solow: Has Financialization Gone Too Far?: Robert Solow has an essay that begins with lots of praise for Ben Bernanke….

Central banking is not rocket science, but neither is it a trivial pursuit…. Running a central bank is in one way a little bit like flying a plane or sailing a boat… every so often a situation arises in which fundamental understanding, knowledge of history, and good judgment can make the difference between riding out the storm and crashing. There was no such person in charge in 1929, and the result was disaster. There was one in 2008….

In March 2012, George Washington University invited Bernanke to give four lectures as part of a course devoted to the role of the Federal Reserve in the economy. The lectures are now reproduced in book form, apparently from lightly edited transcripts…. The lectures are consistently lucid and informal—maybe a little too anecdotal, but illustrated with many clear and informative slides—and above all intelligent and interesting….

He then goes through a long, detailed discussion of the issues Bernanke addresses in these lectures, but I want to pick it up again near the end:

Bernanke's… preferred answer is better and more system-oriented regulation. One has to ask then why regulation failed to see the crisis of 2007–2008 coming and take action to head it off. Bernanke suggests that regulators were lulled into inattention by the so-called Great Moderation…. For safeguarding financial stability in the future, Bernanke seems to count heavily on the provision in Dodd-Frank…

All of which leads to a broader issue…. Any complicated economy needs a complicated financial system: to allocate dispersed capital to dispersed productive uses, to provide liquidity, to do maturity and risk transformation, and to produce market evaluations of uncertain…. Granted all that, however, the suspicion persists that financialization has gone too far. What would that mean? It would mean that the last x percent of financial activity absorbs more resources (especially intellectual resources) and creates more potential instability than its additional efficiency-benefits can justify…. This is, you might say, the $64 trillion question. Maybe I shouldn’t wish it on Ben Bernanke. 

Given his worries about financial stability, I have to wonder if the praise for Bernanke shouldn't be a bit more qualified. I agree that the Fed did a pretty good job responding the the recession. It could have done better -- it was frequently too late and too timid, especially during the first few years -- but it also could have done a whole lot worse. But what we don't yet know is how well we have been insulated from future shocks. Is Bernanke's view correct about what is needed on the regulatory front, and has it been implemented? In my view, significant vulnerabilities remain within the shadow banking system (and I'm far from alone). If that's true and we do have another crisis down the road, then the effusive praise for Bernanke will diminish much as happened with Greenspan (anointed as the best Fed Chair ever only to have housing bubble crash dramatically change the view of his record). As Robert Solow says about Bernanke's views on safeguarding financial stability in the future, "We will have to see how that works out.

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