Almost nobody predicted the immense economic crisis that overtook the United States and Europe in 2008. If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday.

Martin Wolf
Martin Wolf; drawing by James Ferguson

But while prediction is hard, especially about the future, this doesn’t let our economic policy elite off the hook. On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe. As Martin Wolf says in The Shifts and the Shocks, academics and policymakers displayed “ignorance and arrogance” in the runup to crisis, and “the crisis became so severe largely because so many people thought it impossible.”

Did supposed experts really think that nothing like what did happen could happen? Yes. In his 2003 presidential speech to the American Economic Association, Robert Lucas of the University of Chicago, the most influential macroeconomist of the late twentieth century, asserted that “the central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” What he meant was that modern policymakers wouldn’t repeat the mistakes that, according to the prevailing wisdom, made the Great Depression possible.

In particular, Milton Friedman had convinced many economists that depression prevention is actually a fairly simple task, which can be carried out by technocrats at the central banks that control national money supplies. According to Friedman, the Great Depression occurred only because the Federal Reserve failed to do its job in the 1930s; if it had acted to rescue troubled banks and prevent a fall in the money supply, catastrophe would have been avoided.

At a celebration of Friedman’s ninetieth birthday, Ben Bernanke, an eminent monetary economist and Depression scholar who would become Fed chairman a few years later, accepted this verdict: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Then crisis struck, and major central banks—the Fed under Bernanke’s leadership, the European Central Bank, the Bank of England—did everything Friedman said they should have done in the 1930s. Troubled banks were rescued; money supplies were sustained. And we got a depression all the same.

True, in the United States we can comfort ourselves slightly with the observation that, bad as our experience has been, it hasn’t been as bad as the 1930s; but in Europe, where a weak recovery stalled in 2011, and growth between 2007 and 2014 was slower than between 1929 and 1936, they can’t even say that.

How could such a thing happen? If you try to follow the economic debate by listening to the talking heads on TV, or even from press reports, it can seem like a cacophony of voices with no clear theme. That impression isn’t entirely wrong: the crisis has revealed deep cleavages over economic doctrine that were papered over during the good years. But many economists and financial officials (although not as many politicians) have converged on a broadly consistent view about what went wrong—a sort of Standard Model, to make an analogy with physics—that seems to make sense of the mess we’re in. The Shifts and the Shocks is, I’d argue, best viewed as an extended, learned, and well-informed exposition of this Standard Model and what it implies about where we should go from here. Since the new sort-of consensus is clearly much more realistic than the pre-crisis complacency, Wolf, the chief economics commentator of the Financial Times, has performed a very useful service by putting it all together in one readable book.

But is the sort-of consensus the whole story? And are policy recommendations based on this consensus likely to solve our problems? My answers would be “No, not entirely” and “Doubtful.” Before I get there, however, let’s talk about Wolf’s vision of what happened.


The Shifts and the Shocks opens with a long quotation from the late Hyman Minsky, a heterodox economist who had little influence on mainstream economists and policymakers during his lifetime, but whose analysis is now central to the Standard Model. Minsky’s ideas have been cited by monetary officials including Janet Yellen, by business economists like Pimco’s Paul McCulley, and by many academics, myself included. You could say that we are all Minskyites now.

What did Minsky bring to economics? In part, he argued that conventional views of financial crisis were too narrowly focused on the specific issue of bank runs. In Minsky’s vision, excessive leverage—too much reliance on borrowed money—creates a risk of crisis whoever the borrower. Banks, which in effect borrow money short-term from their depositors but invest in assets that can’t easily be converted to cash, may be especially vulnerable. But business and household debt also expose the economy to the possibility of a self-reinforcing downward spiral.


Minsky was not, of course, the first to make this observation; during the Great Depression the great American economist Irving Fisher, in a paper that reads remarkably well to this day, argued that the economy was suffering from “debt deflation,” in which borrowers of all kinds were trying to pay down their debts at the same time, which led to plunging prices of assets and a severe economic slump, which made their debts even less supportable and led to further pullbacks.

What Minsky added, however, was the notion that deflation as a result of excessive debt is fated to happen every once in a while, that periodic financial crises are a more or less unavoidable feature of capitalism. According to his “financial instability hypothesis,” eras of economic stability carry within themselves the seeds of their own down- fall. If there hasn’t been a financial crisis for many years, both borrowers and lenders will become complacent, underestimating the risks of high levels of debt. Leverage will rise, year after year. Inevitably, however, there will come a point when something goes wrong—a financial bubble bursts, a major financial institution fails, whatever—and people will start worrying about debt again. This is the “Minsky moment” (a term coined by Pimco’s McCulley), and it is followed by a nasty case of debt deflation that is very hard for policymakers to fight.

Mapping this story onto the past few decades of US economic history is easy and persuasive. From the mid-1980s to 2007 the US economy did indeed experience an era of relative economic calm, and this in turn induced a very bad case of complacency, not least among policymakers. In 2004 Ben Bernanke gave an influential speech lauding the economy’s “great moderation,” which he argued was likely to be a lasting phenomenon, in part because it reflected the excellence of modern macroeconomic policy. “This now seems quaint,” remarks Wolf; I would have used a stronger word.

What we now know, and should have been obvious even at the time, was that the surface stability of the US economy rested on an unsustainable rise in debt. The graph below, which reproduces one of Wolf’s charts, tells the tale: private-sector debt grew and grew, making the economy ever more vulnerable to a Minsky moment. And the moment came.


In retrospect, the complacency of both policymakers and investors in the face of the trend visible in this chart is remarkable. Why weren’t alarm bells ringing?

One answer was a fallacy of misplaced concreteness: the economics establishment, to use Wolf’s term, identified financial crisis with old-fashioned bank runs by depositors—and such bank runs are a thing of the past thanks to deposit insurance. Yet by 2008 depository institutions were no longer the dominant form of banking. Instead, finance increasingly relied on “shadow banking” (another Paul McCulley coinage): institutions like money market funds and investment banks that are reliant on overnight loans had come to make up more than half the US banking system. And these institutions were both unsecured and unregulated, making them highly vulnerable to panic.

Another answer was vastly excessive faith in the wisdom of the financial industry. Major policymakers convinced themselves and the rest of the world that “financial innovation” was making the system more stable as well as more efficient. Far from opposing or seeking to limit the rapid growth of finance, they sought to promote it; the most important reason instability like that of the 1930s returned to markets, says Wolf, “was simply financial liberalization.”

Finally, policymakers convinced themselves that they could easily contain any major economic fallout from financial disruption, as Milton Friedman claimed the Fed could have done in the 1930s. Indeed, over the course of 2007–2008 official assurances that troubles in the mortgage market had been “contained” were made so frequently that they became a joke. As it turned out, containing the effects of financial crisis is very hard indeed.

This, then, is the Standard Model of the crisis. A long period of relative economic stability fueled complacency in both the private and public sectors, leading to an unsustainable rise in debt. Meanwhile, free-market ideology blinded policymakers to the dangers of growing financial debt, as with the vast number of underfunded mortgages, and in fact led them to dismantle many of the protections we had. And there was, inevitably in retrospect, a day of reckoning, in which the bubble of complacency burst and the fragility of our financial system turned that bursting bubble into catastrophe.

Now, the story I’ve just told is somewhat US-centric, and Wolf argues rightly that a fuller picture requires paying attention to the wider world. This complicates his account in a couple of important ways.


First, as Wolf says, developments in emerging markets, especially in Asia, have in some ways been a mirror image of developments in advanced economies. While the United States was experiencing its “great moderation,” emerging markets were being whipsawed by huge inflows and outflows of capital (made possible by the widespread dismantling of capital controls). It’s interesting to ask why the Asian financial crisis of the late 1990s, which brought Great Depression–level slumps to several economies and pushed Japan into prolonged stagnation and deflation, didn’t shake the policy complacency of Western economists. But it didn’t. (Full disclosure: I did indeed see that crisis as an omen, and published a book to that effect, The Return of Depression Economics, in 1999.)

What it did do was convince emerging markets that they needed huge foreign currency reserves as insurance against future crises. And the enormous accumulation of overseas assets meant that the Chinese and many others were, in effect, lending large sums at very low interest to advanced economies, the United States in particular. In another influential speech, Ben Bernanke dubbed this phenomenon the “global savings glut.” At the time (2005), this analysis was meant to be reassuring: Bernanke was telling his audience not to worry too much about large-scale US borrowing from abroad. But Wolf argues that the savings glut interacted with unsound finance to make America even more vulnerable to crisis.

If the 1990s were an era of crisis in developing countries, the years since 2010 have been an era of crisis in Europe. In a general sense the euro crisis follows the Minsky schema. There was a complacency-fueled rise in debt, followed by a severe slump as many debtors were forced to retrench at the same time. In the European case, however, complacency came not so much from the experience of stability as from the false belief that a shared currency, the euro, eliminated lending risks. Borrowing costs in Spain, for example, plunged in the late 1990s, as it became clear that Spain would indeed share a currency with Germany. Low interest rates, in turn, helped inflate an enormous housing bubble. And when this bubble burst, Spain and other borrowers—with no currencies of their own—found themselves with no room for maneuver, forced into fiscal austerity that deepened their slumps.

While the special circumstances of emerging markets and the euro area complicate the narrative, however, Wolf’s essential story remains that of Minsky’s financial instability hypothesis: stability begets complacency, complacency begets carelessness and hence fragility, and fragility sets the stage for crisis. It’s a good story. But is it good enough?


One of the great temptations one faces in writing about financial crises is the urge to turn it all into a morality play—to emphasize the lurid excesses of the boom, and accept the painful slump that follows as the necessary wages of sin. Liquidationism, the doctrine that policymakers should let a depression run its course, had powerful advocates in the 1930s. Friedrich Hayek, for example, warned against the use of “artificial stimulants” to boost a depressed economy, arguing that policymakers should “leave it to time to effect a permanent cure.”

Wolf is no liquidationist. In fact, he decries the reemergence of “liquidationist folly” at some major international institutions, notably the Bank for International Settlements. Yet I don’t think I’m being unfair if I suggest that in his book, at least, he shows more energy and passion in discussing lax regulation and misplaced worship of the invisible hand than he does in lamenting the inadequacy of post-crisis policies and the damage wrought by austerity. He addresses, briefly, the case for debt relief in economies that, according to his own account, are being dragged down by excess debt, but it almost seems like an afterthought. Or if that wasn’t his intention, it is nonetheless how I suspect the book will be read—mainly as a plea for reining in runaway finance, overshadowing the case for more monetary and fiscal stimulus and more relief for struggling debtors when the economy is depressed.

Emphasizing the need to reduce financial fragility makes sense if you believe that the legacy of past financial excess is the reason we’re in so much trouble now. But are we sure about that? Let me offer two reasons to be skeptical.

First, while the depression that overtook the Western world in 2008 clearly came after the collapse of a vast financial bubble, that doesn’t mean that the bubble caused the depression. Late in The Shifts and the Shocks Wolf mentions the reemergence of the “secular stagnation” hypothesis, most famously in the speeches and writing of Lawrence Summers (Lord Adair Turner independently made similar points, as did I). But I’m not sure whether readers will grasp the full implications. If the secular stagnationists are right, advanced economies now suffer from persistently inadequate demand, so that depression is their normal state, except when spending is supported by bubbles. If that’s true, bubbles aren’t the root of the problem; they’re actually a good thing while they last, because they prop up demand. Unfortunately, they’re not sustainable—so what we need urgently are policies to support demand on a continuing basis, which is an issue very different from questions of financial regulation.

Wolf actually does address this issue briefly, suggesting that the answer might lie in deficit spending financed by the government’s printing press. But this radical suggestion is, as I said, overshadowed by his calls for more financial regulation. It’s the morality play aspect again: the idea that we need to don a hairshirt and repent our sins resonates with many people, while the idea that we may need to abandon conventional notions of fiscal and monetary virtue has few takers.

This, in turn, brings me to the further concern I have with the Minskyite interpretation of the post-2008 depression. Even if you believe that financial excess set the stage for the slump that followed—and despite my sympathy for the secular stagnation view, I guess I mostly do—there was still no good reason why the slump had to be as terrible as it was. Containing the fallout from a financial crisis isn’t nearly as easy as Milton Friedman misled economists into believing, but it’s not impossible. In particular, although you’d never know it from the news media, which play down any success of Obama’s, there’s an overwhelming consensus among economists that the 2009 Obama stimulus substantially reduced unemployment relative to what would have happened otherwise. Given the extremely low interest rates that have prevailed all along, that stimulus could easily have been bigger and gone on longer. What we got instead, however, was a wrongheaded obsession with deficits and unprecedented fiscal austerity, which greatly deepened and extended the slump. European nations had fewer options, because they were and are trapped in a dysfunctional monetary system, but there too the slump was made much worse by wrongheaded policies.

The point is that focusing, as Martin Wolf does, on the measurable factors—the “shifts”—that increased our vulnerability to crisis is incomplete. Yes, rising levels of private debt, increased reliance on shadow banking, growing international imbalances, and so on helped set the stage for disaster. But intellectual shifts—the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices—arguably played an equally large part in the tragedy of the past six years. Say’s Law—the false claim that income is automatically spent—made a comeback. So, incredibly, did liquidationism, the view that any effort to ameliorate the pain of depression would postpone needed adjustment. It’s true that conventional economic analysis fell short in the face of crisis. But when policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like “expansionary austerity”—the unsupported claim that slashing government spending actually creates jobs—that made the situation worse rather than better.

And this makes me a bit skeptical about Wolf’s proposals to avert “the fire next time.” The Shifts and the Shocks is an excellent survey of how we arrived at the mess we’re in, and Wolf’s substantive proposals at the end, especially for reform of the euro system—system-wide deposit insurance, higher inflation so that the burden of adjustment is better shared, among other reforms—are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better?