The world has been plagued by episodic deep downturns. The crisis that began in 2008 in the United States was the most recent, the deepest, and longest in three quarters of a century. It came despite alleged “better” knowledge of how our economic system works, and belief among many that we had put economic fluctuations behind us. Our economic leaders touted the achievement of the Great Moderation.1 As it turned out, belief in those models actually contributed to the crisis. It was the assumption that markets were efficient and self-regulating and that economic actors had the ability and incentives to manage their own risks that had led to the belief that self-regulation was all that was required to ensure that the financial system worked well, and that there was no need to worry about a bubble. The idea that the economy could, through diversification, effectively eliminate risk contributed to complacency — even after it was evident that there had been a bubble. Indeed, even after the bubble broke, Bernanke could boast that the risks were contained.2 These beliefs were supported by (pre-crisis) DSGE models — models that may have done well in more normal times, but had little to say about crises. Of course, almost any “decent” model would do reasonably well in normal times.
KeywordsMonetary Policy Central Bank Economic System Inventory Management Great Depression
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