By Simon Johnson. My testimony to the Senate Budget Committee on these issues is available here: https://baselinescenario.com/2010/08/05/its-hard-to-take-the-fiscal-hawks-seriously/.
There are three main views of the financial crisis and recession of 2008-9. In the first two views, the debate over the fiscal deficit is quite separate from what happened in the crisis. But in the third view, the financial crisis and likelihood of fiscal austerity are closely linked.
The first is that something went wrong with the financial plumbing central to the world’s economy. Failed plumbing is a serious business, of course – great real estate can be ruined by a burst pipe. But it’s a technical issue; nothing deeper is at stake.
The Dodd-Frank financial reform legislation ended up addressing a myriad of technical issues. Clearly, “fix the plumbing” is Treasury Secretary Timothy Geithner’s interpretation of what we need to do – he insists that making the system safer just requires “capital, capital, capital.”
The second view is that the financial system is more deeply broken. Opinions vary in terms of the relative importance of various elements, including too-big-to-fail incentive problems that encourage banks to take on excessive risks – and to be supported by the credit markets when they do.
The first and second views are mutually exclusive – either our financial system is badly broken, or it is not and technical fixes will suffice. Both focus primarily on the nature of the financial system, somewhat in isolation from the rest of the economy. But a third view is increasingly emerging that implies both the first two views are too narrow. Continue reading