How Quickly Can We Recover from the Global Financial Crisis?

Remarks at the Inaugural Symposium of the US-Japan Research Institute

September 22, 2009

It is a pleasure to participate in the inaugural symposium of the US-Japan Research Institute along with my longtime friend and colleague in arms Takatoshi Ito. I should confess that in the past much of our jousting was shoulder to shoulder, but a bit of it was face to face. Today again, I suspect there will be some of each.

My simple answer to the question posed in the title of this symposium is that we can recover from the global financial crisis more quickly than we thought would be possible a year ago or six months ago when the global economy and financial system stopped its freefall. We are in the recovery phase from the financial crisis. The important questions are: What will be the nature of that recovery? And what will be the nature of the subsequent expansion?

In my remarks this afternoon, I first will present my views on where we have been, where we are, and where we may be going in macroeconomic terms. In the second part of my remarks, I will discuss the confused topic of exit strategies and the implications of those strategies for the global expansion.

Where We Have Been, Where We Are, and Where We May Be Going

It is an axiom of sound macroeconomic policymaking and analysis not to be guided by looking in the rearview window. On the other hand, it is also essential to sound policymaking to examine the landscape through which we have traveled and to draw the right lessons from the many casualties that are strewn on each side of the road. Unfortunately, learning the right lessons is easier said than done. There is no shared diagnosis of the origins of this crisis. This fact hampers our ability to learn the proper lessons. This fact also means that I should declare in advance my own perspectives on the origins of the crisis.

Conventionally, the causes of this financial crisis include some or all of four elements: failures of macroeconomic policies, failures of financial-sector supervision and regulation, excesses of poorly understood financial engineering, and the global activities of large private financial institutions.

In my view, macroeconomic policies in the United States and the rest of the fully developed world to a substantial degree were jointly responsible for the crisis. In the United States fiscal policy contributed to a decline in the US saving rate, and monetary policy was too easy for too long. In Japan the mix of monetary and fiscal policies distorted the global economy and financial system; monetary policy was too easy for too long. Once the Japanese economy began to recover earlier this decade, the authorities paid excessive attention to fiscal repair and insufficient attention to restoring normal monetary conditions. Many other countries also had very easy monetary policies in recent years, including other Asian countries, energy and commodity exporters, and—in effective terms—a number of countries within the euro area, as well as the United Kingdom and Switzerland.