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The Crisis of 2008: Structural Lessons for

and from Economics

Daron Acemoglu

MIT

World Bank, February 25.

Daron Acemoglu (MIT) The Crisis of 2008 World Bank, February 25. 1 / 10

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Structural Lessons for and from Economics Mistakes, Challenges and Opportunities

Introduction

Epochal economic events.

Potential threats to our economic system and success.

But also great opportunity for economists and policymakers to learnfrom our mistakes and prepare for future challenges.


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Structural Lessons for and from Economics Mistakes

Mistakes

Three sets of mistaken beliefs have made us complacent:

1

Aggregate volatility has come to an end;2 Marketswithout supporting institutions and regulationscan curbopportunitistic behavior;

3 Reputational concerns of large and established rms will make themmonitor themselves.


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Volatility?

Myth of the end of the business cycle;

Implication of the myth: assetshousing, stockswill continue toappreciate.

Volatility is part of the creative destruction process of the capitalisteconomy;

Successful capitalist economies exploit it rather than falling prey to it.

Conservation law of volatility: reducing year-to-year volatility maybe at the expense of increasing tail risks;

Complex risk sharing and diversication arrangements increaseinterconnectedness and introduce additional counter-party and systemicrisks.


S l L f d f E i Mi k

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Institution-less Markets?

Consumers, shareholders, citizens not suciently informed aboutcomplex products and services;

Standard free-rider problem.

Example both (albeit imperfect) solution: the role of the FDA in thepharmaceutical market.

Institutional checks and regulation important for all markets;

At the very least, for enforcement of property rights and contracts;But also equally as a check against fraudulent behavior.

How do we prevent Ponzi schemes? Or [put the name of your favoriteinvestment bank] schemes?


St t l L f d f E i Mi t k

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Self-Monitoring?

Self-monitoring only works because of equilibrium rents;

There must be something to lose, but how much?

Because of limited liability, large rents, to be forfeited in case offailure and fraud, are necessary.

But punishment not credible, particularly when the specic capitalof those that need to be punished because of opportunitistic behavior

is essential during periods of distress.


Structural Lessons for and from Economics Challenges

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What to Do?

I dont know.



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What to Do?

I dont know.

Nobody does.



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What Not to Do?

Sacrice long-run economic growth;

Halting reallocation;Discouragingdirectly or indirectlyinnovation;Undermining the institutional and political economy foundations of

economic growth.Createor facilitatean expectational trap.

Consumers cutting back on purchases, especially purchases of durables,because afraid of job losses and low incomes;Banks cutting back on loans, because of indebtedness andopportunistic behavior;Firms cutting back on employment and investment because afraid ofdeclining consumer demand and because of high cost of funds.



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Bigger Challenge

Backlash against the capitalist system;

To some degree unavoidablePerhaps even necessary; special interestsparticularly, the nancial

sectorstronger in the United States than previously recognized.We do need smart regulationnot repudiation of the free marketsystem.

We do need innovationnot political economy concerns determining

where public funds will be allocated.We do need reallocationnot protectionism and blanket bailouts.


Structural Lessons for and from Economics Opportunities

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pp

Towards a Better Understanding

Reassessing the role of the nancial system in the management of risk.

Reassessing the role of institutions and regulations in the workings of

markets.Reassessing the interaction between repetition, organizations andmarkets.

Recognizing that even in developed nations, political economy threatsto growth are real.


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