White C O M M E N T

1 INTRODUCTION I wish to begin with a crucial introductory point. According to all of the models commonly in use at central banks and international financial institutions, this crisis was not supposed to happen. Indeed, it could not happen. Modern macro models such as the New Classical, New Keynesian, and DSGE models rule out extended economic disequilibria by assumption. More traditional structural models rule out such outcomes inadvertently by paying too little (if any) attention to the factors now commonly believed to have both precipitated the crisis and to have contributed to its longevity. Here I am referring to the whole gamut of credit, leverage, stocks (especially of debt), and the gradual build-up (now unwinding) of " imbalances " in the real economy. By " imbalances " I mean asset prices that rose to levels that were increasingly hard to explain in terms of fundamentals, as well as financial institutions that became exposed to a variety of risks that threatened their solvency. The dangers posed by these financial imbalances are now being addressed in the context of the broader search for " financial stability ". However, other imbalances also built up, affecting the real side of the global economy. Household savings rates in English-speaking countries (and some others) fell to zero, and sometimes well below. Fixed investment ratios in China rose to over 50% of GDP, a level never seen before in market-based economies. And, as a by product of these domestic imbalances, global trade imbalances also rose to unprecedented levels. Finally, as supply responded to demand-side pressures, whole industries expanded beyond sustainable levels (construction, financial services, global distribution networks, etc.), implying a need for subsequent downsizing. These real-side imbalances are still not receiving the attention they deserve. The crisis was triggered in the summer of 2007 by the recognition of problems in the financial sector, but could just as easily have started on the real side of the economy. Whatever the trigger, the fundamental point is that the imbalances on the real and financial sides interact in both the upswing (" boom ") and the downswing (" bust ") of the credit cycle. While some of the imbalances revealed by the crisis have subsequently been reduced, most of them still remain. This is the fundamental reason for doubting the robustness and sustainability of the recovery seen recently in the global economy. Of course, the fact that commonly used models …