Indeed, what is worrisome is that the dimensions of the crisis that follow the Lehman collapse were no anticipated by the authorities. With the benefits of hindsight, it would have been better to avoid the collapse, and its effects should have been foreseen by policymakers. The consequences of the financial crisis will spread past the financial system, as is already perceived in recent discussions on privatization of earnings and socialization of losses. Hopefully this debate will soon focus on the important issues, but we must recognize that the excessive aggressiveness and ambition of some players in the international financial markets, the irresponsible behavior of operators unaware of what they were trading, and lax risk assessment and regulation, will penalize the innocent and the guilty alike. A sound, competitive financial system is essential for economic development. The incentive structure is key for its smooth operation. If no credit exists, only those owning the resources could invest or buy durables. The financial markets allow the anticipation of consumption and invest. But its stability must be safeguarded to ensure efficient credit allocation and proper risk management. One issue that has been discussed in monetary policy theory and practice is how to handle bubbles. The conventional view is that nothing can be done to prevent them; that they cannot be detected, that they must be a cause for concern only to the extent that they affect inflation, and that the only thing to do is to clean the mess after they burst.
Should we conclude, therefore, that in the absence of a world government, the identification of “new rules of the game” is likely to be no more than a theoretical exercise? Certainly, the fate of Keynes’ proposal for an International Clearing Union is not encouraging. But the experience of the past twenty years shows that large imbalances mean that everyone suffers when there is a sharp adjustment. So there is scope, if not for formal international policy coordination, then for an international conversation about how to improve a system that is fragile. Central banks were able to ensure, for a while, that the paths of output were sustainable – consistent with low and stable inflation. But the patterns of demand were far from sustainable. And when the sharp adjustment to demand eventually came, it inevitably had implications for the level of output. Reform of the IMFS, and of our domestic financial systems, is a necessary complement to the domestic price stability oriented policy frameworks of central banks. The immediate issue of how to move to a more sustainable position requires a resolution of different countries’ economic strategies for rebalancing. There can be only one path for rebalancing – with rebalancing in the deficit economies, by definition, just a mirror of that in the surplus countries. But the path that would be chosen by high-saving economies differs from that which the more indebted industrialised economies would prefer.