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Rebuilding credibility in 2010

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25 January 2010 12:02

The GFC has been bad news for the credibility of a wide range of economic actors. To provide just a few examples: the economics profession has taken a pounding; Wall Street’s Masters of the Universe have been recast as villains, con artists, and even vampire squids; central banks stand accused of bungling monetary policy either for leaving rates too low for too long or for neglecting rapidly inflating asset prices; rich country regulators and politicians are alleged to have been co-opted by a financial oligarchy; the G7 club of rich countries looks to have faded into irrelevance; and the image of competent Western economic management has been trashed

2010 will be a year for rebuilding the credibility of several players in the world economy.

Starting with economics, Arvind Subramanian has already mounted a case for the defence. His reasonable point is that the unprecedented policy response to the GFC has been sufficient to prevent a re-run of the 1930s — and so in the sense that policymakers have not repeated the mistakes of the past, economics has made a significant contribution after all. 

Unfortunately, the case for the prosecution can respond that many economists continue to disagree over what the policy response should have been, whether it has been too large or too small, and more fundamentally still, whether a policy response was even necessary. Still, natural experiments on the order of the Great Depression and the GFC (thankfully) do not come around very often, so when they do, its reasonable to hope for another paradigm change in the economics profession.

What about the future of the financial sector in the crisis-hit economies? For the (surviving) banks, government bailouts and historically low interest rates mean that many of them have actually been doing rather well in the aftermath of the crisis, and until recently they have had to deal with  surprisingly little change in their regulatory environment. Their recent good fortune has not exactly endeared them to a public now facing looming cuts to public spending and increases in their tax bills, however, and this has left the financial sector looking politically vulnerable.

Central banks have seen public trust in their abilities decline after the crisis, although this appears to have been most pronounced in Europe. The future path of central bank credibility now depends heavily on how, and more importantly, when, they decide to exit from their current, crisis-driven policy stance. Getting their exit strategies right will be crucial not only for the health of the economies they manage, but also for their future standing.

Then there are the regulators and the politicians. The recent announcement by President Obama of a new regulatory order for US banks — described in the FT’s editorial as a ‘declaration of war on Wall Street’ — suggests that the long-anticipated political and regulatory backlash against the financial sector is now underway.

It’s too late to worry about rebuilding a role for the G7: those days are gone. Instead, 2010 will about building the credibility of the G20. The latter had a pretty good crisis, with the London Summit doing a reasonable job of showcasing international economic cooperation in the face of the GFC, and the Pittsburgh meeting locking in its new status as the world’s peak economic body. 

But the grouping is likely to be judged more harshly this year. G20 meetings are scheduled for June (Canada) and November (Korea) and observers will be looking for meaningful progress on the range of items identified at the 2009 meetings. The failure at Copenhagen at the end of last year serves as a powerful recent reminder of the difficulties involved in generating effective international cooperation.

Finally, what of the general credibility of Western economic management? In part, it will be determined by some of the issues listed above — the success or otherwise of regulatory reform of the financial sector and whether central banks get their exit strategies right. But it will also be influenced by how politicians and policymakers manage the looming challenges posed by growing debt burdens, large fiscal deficits, and disgruntled voters. The resulting interplay between politics and economics is going to be another important feature of the coming year.

Photo by Flickr user dorkula (Carrie Sloan), used under a Creative Commons license. 

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