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Time for the queen to pop the question

LiveMint logoLiveMint 31-07-2017 V. Anantha Nageswaran

Gavyn Davies was the global head of Goldman Sachs’ economics department for 14 years from 1987-2001. He also headed the BBC Corp. from 2001-04. For the last several years, he has been writing a regular blog in Financial Times. His column on 23 July, “Have They Really Fixed Financial Instability?” offers plenty of food for thought.

He started his column by recalling an observation of Janet Yellen that the world was unlikely to face a financial crisis in our lifetimes. Of course, it depended on what she thought about her or others’ lifespans. But it was breathtaking and troubling that she should say so. Whether it turns out to be a more hubristic statement than that of Ben Bernanke, who ruled out a nationwide decline in home prices and also opined that the financial crisis had been “contained”, remains to be seen. 

Second, Davies correctly points out that prosaic warnings on financial stability follow pages of paeans to market resilience, to financial stability, etc. He had the Federal Reserve monetary policy report to the US Congress in July 2017 in mind, I think. Such confident assertions encourage needless risk-taking on the part of market participants. Again, that reminds us of Alan Greenspan’s repeated statements on “once in a lifetime improvement in productivity” that underpinned investors’ irrational exuberance on technology stocks in the 1990s. 

Systematic rejection of humility, embrace of hubris and utter disregard for “unknown unknowns” (how can one so easily forget all the ignorance at policymaking bodies on the extent of leverage that had built up prior to 2008?) go against the facile assumption that economists make on human rationality. That assumption appears egregiously wrong with respect to key Federal Reserve officials—past and present.

Third, the Federal Reserve, despite the 2008 crisis, has refused to take into consideration financial stability factors in the setting of monetary policy. Neither has the International Monetary Fund (IMF). In its Article IV report on the euro area released recently, the IMF firmly advised the European Central Bank (ECB) against what it called “premature withdrawal” of monetary stimulus. Incredible. The balance sheet of the euro system of central banks was close to 35% of gross domestic product (GDP) in the euro area. About a decade ago, it was less than 10% of the area’s GDP. This advice flies in the face of the observation that eurozone governments have done precious little to take advantage of the low funding costs that the bond-buying programme of the ECB had engineered to put their fiscal positions in order. Further, the report also notes that contrary to the advice of the IMF, most of the highly indebted countries, including France, Italy and Portugal, were preparing to ease fiscal policy in 2017. Not a surprise. Reforms are undertaken only in the face of teething pain and not when things become comfortable. It is true of individuals, institutions and sovereigns. 

The IMF warned the Federal Reserve too in 2015 and in 2016 against premature tightening. The Federal Reserve hiked the policy rate only once each in 2015 and 2016. What does it have to show in return for its advice? Real estate, stock market and junk bond bubbles around the world. Further, the IMF has cut the growth rate for the US for 2017 and for 2018 in its latest World Economic Outlook update. The IMF appears to have learnt nothing and forgotten nothing. It must be held squarely accountable for the next financial market meltdown, which does not appear far off, given the elevated valuations in many asset classes around the world.

The IMF is part of the problem, as are major central banks, with respect to its embrace of monetary policy snake oil that delivers no growth but delivers on market instability and inequality. Why, Davies himself muddied the waters with his blog post on 2 July in which he appeared to chastise the Federal Reserve for ignoring low inflation.

This is an example of analytical and intellectual inconsistency that encourages policymakers to be indifferent to financial stability and financial cycles. In turn, they encourage market participants to take on more risk, reassuring them that they are not contemplating spiking their punchbowl. Research by Anna Cieślak and Annette Vissing-Jørgensen have shown that the Federal Reserve is unduly and excessively considerate of downside risks to the real economy from declining asset prices—much more than what empirical evidence would warrant. 

Unless intellectuals are consistent themselves (that requires a clear head on their part, to begin with), they cannot hold policymakers to account or to a higher standard. In the end, intellectuals and policymakers encourage market participants to take on more risk than they absorb and be myopic in their asset allocation decisions—focusing only on return and ignoring risk considerations. The rigmarole continues with brief and sporadic bouts of sanity around and shortly after a crisis strikes, with a return to familiar insanity once memories fade. 

The British queen is supposed to have asked, after the 2008 crisis, why economists did not see it coming. It is time for her to ask intellectuals if they really deserve their reputation of failing to learn from the mistakes of the last crisis.

V. Anantha Nageswaran is senior adjunct fellow (geoeconomics studies) at Gateway House: Indian Council on Global Relations, Mumbai. These are his personal views. Read Anantha’s Mint columns at

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