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July 28, 2009 12:03 pm
Reflecting on the credit crunch, Her Majesty the Queen was right to ask ‘why did nobody notice it?’ However, she seems to have been given an incoherent and unhelpful answer.
If the ‘failure of collective imagination of many bright people’ is the right answer, economists should bury their heads in shame. The credit crunch and its aftermath were not only foreseen, but several economists were pretty good with their timing too. This suggests a wider refusal to recognise the build-up to the bust, rather than a failure to see it coming.
JK Galbraith remarked that one of the greatest pieces of economic wisdom is to know what you do not know. Regulators and supervisors did not know complex financial products and processes, or the impact of low economic volatility on risk management systems.
However, economists knew about vast debt accumulation, and how it supported spreading asset bubbles. Those in a position to address this refused, or were too timid. They also knew full well about global imbalances and their complicity in financial excess, especially after 2002. The question is why, as recently as 2007, they refused to recognise the freefall in subprime prices and financing structures as the tip of a giant systemic iceberg with grave economic consequences?
The answer is that economists in the public, banking and academic sectors were, in their different ways, beholden to the long boom of the last 25 years, and to its ideological origins.
What they did not know is what they chose to forget or ignore, namely that all big disturbances in the real economy originate in the financial sector. No failure, then, of collective imagination as to why nobody noticed it, Your Majesty, but a huge mea culpa: bright people had vested interests too. Economics is about judgement and humility is deserved.
George Magnus is senior economic adviser, UBS Investment Bank, and author of The Age of Aging
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