Fault Lines: How Hidden Fractures Still Threaten The World Economy

by Raghuram G. Rajan

The U.S. financial sector thus bridged the gap between an overconsuming and overstimulated United States and an underconsuming, understimulated rest of the world.

We have long understood that it is not income that matters but consumption. Stripped to its essentials, the argument is that if somehow the consumption of middle-class householders keeps up, if they can afford a new car every few years and the occasional exotic holiday, perhaps they will pay less attention to their stagnant monthly paychecks.

“The kids in Connecticut prep schools smoked pot and went on to college like their parents; kids in rural Indiana smoked meth and dropped out; kids in the South Bronx smoked crack and died in gang wars.”

The real problem, in my view, is that developing countries, certainly in the early stages of growth, do not have the organizational structure to deploy large quantities of physical capital effectively.

As I argued earlier, the recent crisis was not caused only by lending to the poor!

In a haunting parallel to Robert Lucas’s famous critique of Keynesian models, in which he argued that those models would break down because modelers did not account for how the economy would react to policies that attempted to exploit past correlations in the data, modeling that took the plumbing for granted ensured the breakdown of the plumbing.

In the jargon of economists, that the market is believed to have rational expectations about events does not mean that it has perfect foresight.

Ironically, faith in draconian regulation is strongest at the bottom of the cycle, when there is little need for participants to be regulated. By contrast, the misconception that markets will govern themselves is most widespread at the top of the cycle, at the point of maximum danger to the system.

Although large institutions are more likely to be systemic, size is neither a necessary nor a sufficient condition.

Every systemically important institution should meet with regulators periodically to review its “living will,” a plan that would enable it to be resolved quickly— ideally, over a weekend—in the event of imminent failure.

Forecasting is always difficult (especially about the future!),

The steady deterioration of India’s once superb universities needs to be reversed.