In August 2005, Raghuram Rajan, an economist at the University of Chicago’s Booth School of Business, predicted the financial crisis. And he did it at possibly the least friendly of venues: a conference of high-powered economists who had convened in part to honor Federal Reserve Chairman Alan Greenspan.
Rajan presented a paper titled “Has Financial Innovation Made the World Riskier?” His answer, put simply, was “Yes.” He was dismissed by the assembled masters of the universe. “Misguided,” said Larry Summers. But Rajan was right.
In this month’s Foreign Affairs, Rajan is back with another warning. “The industrial countries have a choice,” he writes. “They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called ‘animal spirits’ must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities.”
This time, Rajan’s comments are being received more favorably. Greg Mankiw, the Harvard economist who advises Mitt Romney, called the essay “wise.” Tyler Cowen, the George Mason University economist who runs the popular blog Marginal Revolution, was even more direct: “Rajan nails it,” he wrote.
But he is once again on the opposite side of the issue from Summers…