To the editors:
The rich analyses in Mervyn King’s book, upon which Henri Lepage has expanded in his review, have one great virtue: they make us think. In his book, King provides a two-fold account of his experience: the first, academic in nature, at the London School of Economics (LSE) and the second, operational, as head of the Bank of England. He retraces both the theoretical foundations of his actions and the institutional framework in which they were exercised. These two aspects lead me to make the following observations.
Economists, and even central bankers, have been indicted with respect to the last great crisis: none of them saw it coming. During a memorable visit to the LSE in October 2008, the Queen of England reproached them in person. King’s explanations, which Lepage comments on, sometimes critically, seem to me incomplete. They continue to disregard any link in economic reasoning between the production and the exchange of goods and services that are the objects of their attention, represented in increasingly sophisticated models, and the financial situation of economic agents. Their characteristics and evolution are from another sphere, one without any direct impact on the real world. There is Main Street and there is Wall Street; each responds to its own logic, with few interactions between them.
I had occasion to explain how imperfect this traditional conception was at a conference at the Turgot Institute. I noted that disequilibria in private finances—the source of the crisis—could not have been accounted for, since both household and business debt were absent from the models in use at the time. This was why economists had not seen anything coming. A rethinking of economic analysis involving the integration of financial data is therefore necessary so that in the future such crises do not recur.
I am of the opinion, as is Lepage, that King’s explanation—i.e., interest rates had been kept too low by the central banks, which in turn had encouraged American households to accumulate excessive debt—is insufficient. A rise in the rates by two or three points, which is considerable, would have changed nothing. Banks would not have been more careful about the quality of borrowers, as they were assured they could rid themselves of these debts through securitization. It was the failure of the financial authorities to take into account overall private indebtedness—and furthermore, of the political powers that allowed the disequilibria to worsen—that was the source of the crisis. But how could they be blamed for this? For economists, regardless of the school of thought to which they belonged, the level of private indebtedness was not a relevant concept and did not appear in their models. The phenomenon was not limited to the United States. Ireland, Spain, and Portugal were confronted with analogous crises shortly thereafter. There is, therefore, still much work to do—thinking and modeling—to formalize the interaction between the operating accounts of economic agents and their balance sheets in order to prevent this new type of disequilibrium.
Lepage’s observations on the institutional aspects of King’s book also seem to underestimate the political stakes. Throughout the world, the state must intervene to correct disequilibria. As their margins for budgetary and fiscal maneuvering are limited, central banks are called upon to step in. Their activity is no longer limited to restraining demand in order to reduce the pressure on prices by acting on the supply and price of money, as required by their historical mandates. The European Central Bank, for example, seeks to do the opposite, by setting themselves the target of raising inflation to 2%.
Reflecting on the future of the central banks—and here Lepage and King take different positions—is interesting but it does not seem to me really relevant. The issue at hand is the economic efficiency of monetary policy and its limitations; there may, in fact, be a contradiction between economic priorities and prudential requirements. How can we prevent the abundance of monetary resources from weakening the banking and financial system? This is the question of how monetary policy translates to the real economy. On the one hand, there are resources, but, on the other hand, their use is taxed through solvency ratios. The field of future reflection is wide-ranging and the challenges facing the central bankers—who, as part of their mission, also supervise financial institutions—are considerable. The debate over possible solutions is therefore far from over.
Alain Boublil
Henri Lepage replies:
I remember well the conference at the Turgot Institute in October of 2009 to which I invited Alain Boublil.1 Here is how he summarized for us his diagnosis of the origins of the crisis:
The reason is simpler than anyone has said: contemporary economics, and more precisely, macroeconomics, can no longer describe the phenomena that take place in developed countries and the mechanisms that generate them. It spreads misconceptions because the concepts that it deals with and the models it uses take only very partial account of reality. The consequence is that it leads policy makers to inappropriate decisions. Incapable of predicting crises, economists offer irrelevant solutions in the guise of remedies.
This is a devastating analysis that refutes the central point of the book written by the former governor of the Bank of England, just as do my ideas2—but seven years in advance. Bravo.
Boublil has focused his criticism on the total lack of financial data in the structure and functioning of the formalized models used by the economic and monetary authorities. In particular, they do not take into account the disequilibria in private finances that played such a determining role in the dynamic of the crisis. I had been very interested in this approach, which I was not familiar with, but at the time I had not been particularly struck by it. It was not until much later that I realized its importance, when I first began to discover the work of the Bank for International Settlements (BIS) economists, whose findings I briefly summarize in my essay.
I think Boublil should be proud to see the programmatic propositions that figured in the conclusions of his 2009 speech now serving as a work plan for what seems to me to be one of the most promising projects of economics research of our time. But with this caveat: the objective of integrating the financial and monetary variables into economic analysis should not, as he wrote in his letter, become that of “correcting disequilibria,” but, much more fundamentally, of stopping them from forming and accumulating far in advance of the processes that inevitably give birth to them. This is clearly understood by the authors of the new generation of macroeconomic models being experimented with at the BIS laboratory in Basel.
Translated from the French by the editors.
