Rogoff: Brave New Financial World

Like Edmund Phelps, Kenneth Rogoff is also worried about regulatory overreach in response to the crisis:

Brave New Financial World, by Kenneth Rogoff, Commentary, Project Syndicate: A huge struggle is brewing within the G-20 over the future of the global financial system. … In all likelihood, we will see huge changes in the next few years, quite possibly in the form of an international financial regulator or treaty. …

The United States and Britain naturally want a system conducive to extending their hegemony…, other countries would like to see more fundamental reform. Russia and China are questioning the dollar as the pillar of the international system. … These are the calmer critics. …Czech Prime Minister Miroslav Topolanek, openly voiced the angry mood of many European leaders when he described America’s profligate approach to fiscal policy as “the road to hell.” He could just as well have said the same thing about European views on U.S. financial leadership.

The stakes in the debate over international financial reform are huge. The dollar’s role at the center of the global financial system gives the U.S. the ability to raise vast sums of capital without unduly perturbing its economy. …

More fundamentally, the U.S. role at the center of the global financial system gives tremendous power to U.S. courts, regulators, and politicians over global investment throughout the world. That is why ongoing dysfunction in the U.S. financial system has helped to fuel such a deep global recession. …

Fear of crises is understandable, yet without these new, creative approaches to financing, Silicon Valley might never have been born. Where does the balance between risk and creativity lie?

Although much of the G-20 debate has concerned issues such as global fiscal stimulus, the real high-stakes poker involves choosing a new philosophy for the international financial system and its regulation.

If our leaders cannot find a new approach, there is every chance that financial globalization will shift quickly into reverse, making it all the more difficult to escape the current morass.

As I said here in response to an op-ed by Becker and Murphy where they also express concerns about regulatory overreach, my fear is the opposite, that powerful interests will prevent us from taking the steps we need to take:

While it’s possible that regulation will go overboard in response to the crisis, there are powerful interests that will resist regulatory changes that limit their opportunities to make money (and [anti-regulation] Nobel prize winning economists willing to back them up), so my worry is that regulation will not go far enough, particularly with people like Kashyap and Mishkin arguing that we should wait for recovery before making any big regulatory changes to the financial sector. They may be right that now is not the time to change regulations because it could create additional destabilizing uncertainty in financial markets, and that waiting will give us time to see how the crisis plays out and give us the time to consider the regulatory moves carefully. But as we wait, passions will fade, defenses will mount, the media will respond to the those opposed to regulation by making it a he said, she said issue that fogs things up and confuses the public as well as politicians, and by the time it is all over there’s every chance that legislation will pass that is nothing but a facade with no real teeth that can change the behaviors that go us into this mess.

I was talking about the U.S., but the same is true at an international level where change is even harder to coordinate, and the danger that compromise to please all will produce reform that does little to restrict behavior is even greater.


Originally published at the Economist’s View and reproduced here with the author’s permission.