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Of Prancing Horses and Bolted Stable Doors: Financial Crisis, Recession, and Policy CAO Challenge Day 20th February 2012 A Generational Perspective The evolution of economic thinking can be illustrated through the experience of successive generations: • Today’s young adults - “the return of depression economics” (2007-??) • Their parents - “the end of history” (19792007); • Their grandparents – “the managed economy” (1945-1973) “Greed is good” EVOLUTIONARY LIBERALISM: FROM POWER TO PLENTY? Lt. Gen. Mikhail Kalashnikov with vodka (20th September 2004) Prudential Ratios in Banking Assets Liabilities Liquidity Reserves Deposit Liabilities Government Securities Non-Deposit Liabilities Loans Equity (Shareholders’ wealth. Two Hypotheses on finance • Efficient Markets – Finance “oils the wheels” of the market – It speeds up income convergence at lower cost in current consumption – Rational expectations ensure stability – Competition empowers rational expectations • Financial Instability – Expectations intrinsically volatile – Volatility creates real economic damage – This damage can be long-lasting (hysteresis) – Prudential regulation must be strict “You stupid boy!” MONETARY POLICY I: INTEREST RATE MONETARY POLICY II: QE EUROPEAN FINANCIAL REGULATION: BETWEEN EMH AND FIH Source: Committee of European Banking Supervisors Annual Report 2004. CONCLUSIONS • The biggest negative shock since the 1930’s • Was initially met by a much bolder macroeconomic response • Leading to a faster recovery than anticipated • But “the markets”, missing “sound finance”, are gunning for Greece and other Eurozone members; • Policy-makers may be losing their nerve: • Can Keynes still be the “defunct economist ... academic scribbler” to enslave them/inspire you/revive public governance?