showed that when there is a significant asymmetric information some markets may not exist his uh theory which uh referred as an example to the market of second-hand cars is a kind of reasoning which then spread on many other areas and economists in a way paved the way to a new way of thinking i'm not going to mention again the example on which he based his intuition also because talking about the market of second-hand cars is not very trendy now there's a major attempt underway to stimulate the sales of new cars particularly in times like these uh when we talk about fiat and opel we shouldn't really talk about that because the information that we are getting is not always so encouraging but i there are many other topical examples let's think for example of the problem of the crisis the purchase of bank uh assets during the crisis with potential buyers who were not aware of the amount of toxic assets provided by these banks or about their quality indeed so they find themselves they found themselves buying a bank which was made up of uh just a few good components and a lot of rubbish the amount of rubbish is uh minor uh the whole thing can be acceptable but if it's the other way around if it's the majority surely it cannot but there's also another case which is being debated during these days we very often talk about social dampers and we should ask ourselves why these things are only given by governments and not by private insurance companies private insurance companies should apply very high premiums if they wanted to do that again because of a problem of asymmetric information moral hazard in other words people's attitude may influence their likelihood of being unemployed but if the companies had to analyze the premiums used to this end they would attract people who have the highest risks of losing their jobs and the result of that would be a failure of the whole system and that is why it is governments that impose this kind of insurance themselves this these are just few examples of the great value the great significance of this theory of adverse selection and the impact it has in our daily lives uh professor arkelov already had an and nobel prize but a second reason why he would be awarded one related to uh his notion of identity a notion that was recently applied to economics in an attempt to understand how people um or how economic uh behavior is also influenced by non-economic factors in other words how people perceive the values and the objectives of their lives this too was developed with regard to very specific cases george arcoloth and rachel crackton used this to understand the high degree of crime and marginalization among u.s afro-americans uh showing that this is related to an identity of this community that tends to oppose or reject rules and this in turns tend to prolong this condition in the light of these theories and these analysis uh the wall street journal recently published an article on the role of barack obama where george akalov said we've had major uh changes in american history and now we hope that what we are being viewing now is a new major change a new paradigm and hopefully this will be always an important memory related to barack obama if he manages to i mean at the very fact of having uh the first black person as president of the united states uh this will be much more important than the bank saving plans that are being discussed over these days but today as i said we're going to talk about identity and rather quantum tomorrow will focus specifically on that during his lecture uh at 6 30 pm at the one consider castle so it will be a continuation of what we're going to say today with dr arkhilov but today we are going to address more specifically the second part of the title of our festival a global crisis in unsuspicious times george aikolov gave a major contribution to the redevelopment of keynesian thinking during his nobel prize speech he attacked the conformism of the macroeconomic theory that was opposing uh cain's theory and he mentioned an important article called after keynesian macro to claim that uh keynesian thinking was not really outdated or updated and all behavioral macroeconomics is based in fact uh to a large extent on kane's way of thinking the common uh trait of this analysis is the attention it gives to human psychology george accolaf's contribution to economy has been compared by some people to freud's contribution to psychoanalysis animal spirits the book we're going to talk about today is actually um analyzing the present crisis from this standpoint in an attempt to interpret it and understand why and how it developed there are some parts of the book that concern actually specifically uh the crisis that we are experiencing now all over the world but i don't want to take any more of your time and i'll give the floor uh without a due to professor george akeloff thank you very much it's a great honor to be here um first of all it's just wonderful to have a festival about economics and yet more to have a festival about economics in which identity might be one of the questions so um i'm going to speak about my recent book with bob schiller and it's called animal spirits in english and it's called spirity animali in italian and i'll show you this one because it's clear so um i think the spirit of this book we asked one of america's leading cartoonists ed koren to draw to make the cover drawing and he read the book and i think he's caught the spirit of the book he caught the spirit of the book better in fact than i'm going to give you because i'm going to give you a much more formal version because i'm going to try to condense everything of course he condensed it into a cartoon and what you see is you see these nice animali i guess that's what we should call them and there's a nice one here who's this this thing you see this uh graph which must be the stock market and this pillow is really he's really at the top and he's very happy and then the thing goes down and you can see it goes down precipitously and this person is scared he is really really scared and then you see this person he's hanging on for dear life and then it goes up this guy is really happy and then he goes down again and he's again hanging on and so so it goes and so that's the spirit i think that's the animal spirit that is taught that we're talking about about how the economy works so um the book has a large number of stories and we make our point uh largely in stories can you hear me and back okay so i'll uh i'll just use this one uh so um so uh so i'm going to concentrate my remarks here not just on the whole book but how we got into the current economic and financial crisis i'm also going to concentrate my analysis on the united states since i believe that the united states is at the epicenter of this crisis so governments the world over are trying to solve it and they're enlisting economists uh you sit down okay all right so i'll sit down uh oh maybe i'll maybe i'll try this okay okay we'll see what happens okay okay so government's the world over good one okay so governments the world over are trying to solve it and they're enlisting economists uh to guide them through it now economist sorry you need to keep it closer so economists rely on their vision of macroeconomics and of course much of that vision comes from john maynard keynes now getting it right then calls for a correct vision of how the economy works and the role of animal spirits the role of this book is to provide such a vision okay so current versions of macroeconomics greatly play down the role of psychology in the macro economy but as we show in our book there are at least eight fundamental macroeconomic questions whose answers depend largely although not entirely on the role of psychology so the first task of the book is to explain the role of psychology in the macro economy and in answering these eight questions so cain's called this role the role of people's animal spirits and the first part of the book describes five different animal spirits what are they their confidence fairness corruption and bad faith money illusion and stories and then the second part of the book describes how these animal spirits play a key role in the answer to these eight macroeconomic questions now these questions are fundamental they're as fundamental as why does the economy fluctuate as much as it does why and how monetary and fiscal policy affect the economy and why there's involuntary unemployment so let me review just briefly how these concepts indicate how we've gotten into the current crisis and then i'll review some of the particulars of the crisis in the united states so let's first turn to confidence the first of these animal spirits is confidence now the dictionary the dictionary tells us the confidence means trust but what does trust me trust means the people go beyond the usual rational use of information to make judgments and that is just what we found in the boom that just ended what we found was the people were making all kinds of business investments and especially they were purchasing and selling complex financial instruments on the basis of their trust and this wasn't just in the housing and the mortgage market it occurred in financial markets much more generally furthermore they would have not have made these investments if they had rationally analyzed the basis for making them they made them because they were confident and as it turns out they made them because they were overconfident okay so that's the first one so let me describe now the role of corruption and bad faith so very few economists foresaw the problems that were developing the standard view among economists was the private markets would be self-policing that standard view assumes the people would be knowledgeable buyers and sellers and they would only undertake increased risk for example if they were duly compensated by higher expected returns so there was little worry about the absence of regulation in both the securities and the real estate markets but the self-policing view does not take appropriate account that people were overconfident and therefore they did not do they did not do the self-policing that they were supposed to do now there's a principle of capitalism which means the capitalism will take advantage of overconfidence so so it's true the capitalism will produce what people really want as long as people can make a profit but more subtly and more generally capitalism also produces what people think they want as long as firms can make a profit so think about it unregulated capitalism may produce good medicines that cure our ills i i believe it will but unregulated capitalism also produces snake oil that does not cure our ills it may even find it profitable to produce the desire for the snake oil itself and in fact that's one major reason for the food and drug administration in the united states just to be sure that you have the proper translation for snake oil in the book it's called remedia di charlatani okay but we call it more i think the united states we have a better name for it we call it snake oil so the food and drug administration plays a role it protects us against buying snake oil medicine now the book's full of stories and so we tell lots of stories and one of the stories is rel is relevant to this so william rockefeller who was the father of john d rockefeller the first in the 19th century he would tour the united states mid middle west in his buggy anyway when he reached a new town he would go to the town square and he would give a talk and he would distribute flyers saying that dr rockefeller was in town he had arrived and he had the miraculous cures and then he would repair to the best hotel suite in town and sell his wares to those who came for the cure for their ills and indeed the contrast between william rockefeller and his son is apt because william was selling snake oil and that represented one side of capitalism whereas in contrast his son john d sold real oil that real oil was used to light people's lamps in the 19th centuries and then later was used to fuel people's cars and that represents the productive side of capitalism now the principle of snake oil when you think about it has special relevance it has special relevance for asset markets now what are assets to most people financial assets to most people are only pieces of paper or maybe they're just something that exists in cyberspace so what most investors do is they surmise the value of financial assets from others such as accountants and rating agencies tell about them and those accounting and rating agencies also have their own incentives and those incentives are not fully aligned with the public's interest and so when people are over confident when they're overconfident financial markets tend to produce assets that take advantage of their overconfidence if unprotected by effective regulation people will be then sold snake oil assets and furthermore what you expect to have happen as a as a matter of equilibrium is that is that a whole industry will arise to produce them and that's exactly what we've seen in wall street and beyond okay so that's the second of the animal spirits that i'm going to talk about so there's a further animal spirit which bolsters the previous two people act and think and live in according to stories so i see most of the people in the audience are probably old enough so you're probably married or a lot of you are married think about your marriage most marriages associated with most marriages there is a story there's a story about who you are there's a story about who your spouse is and in fact as you get older one of these stories enrich your marriage and it's one of the things that you live with and uh and makes a good marriage especially a good marriage it isn't just what goes on currently it's the story and where you are and how you live well that goes uh it isn't just that people live according their stories in most of their lives that also goes for their economic decisions as well as their personal decisions and there's usually a story then about how the economy is behaving as it does the stories then have some grain of truth but they often are over exuberant on the one side or too pessimistic on the other so just think about it ten years ago ten years ago there was the dot com story we lived through that and then it went away in the recent past there was another story there was a news story the story was that financial engineering could make financial assets much more safe than the underlying securities there was some kind of modern financial alchemy done by smart people like economists like us which could find do which could engage in financial packaging that had figured out ways to reduce and maybe almost eliminate financial risk and what happened people bought into these stories people were over confident and then markets took advantage of those beliefs to sell them what was later proved to be snake oil assets so why does the economy so why does the economy fall into recession these three animal spirits then explain how fluctuations in human psychology play a key role in why the economy fluctuates as much as it does we think bob schiller and i think that that is the key role in business cycle fluctuations what happens the confidence comes and the confidence it goes the stories come and the stories go and the snake oil comes and the snake oil goes so we think that the current financial crisis is explained exactly by such fluctuations and so that's one major thrust of the book and this tells us the origins of the current financial crisis okay so now let's apply these principles more deeply to the current crisis and i'm going to talk specifically about the united states which is what i know most about but i think it's also especially important there it's especially important there because i think that this is a crisis that's centered in the united states but then the same over exuberance for similar reasons has infected the whole the rest of the world so let's turn to the united states okay okay so we're going to talk about what are the powers of the fed or why does the fed have effect insofar as it does okay so there are limitations first of all to the power of conventional open market operations which is which is control over interest rates they occur when short-term interest rates have been driven down to zero but then as it turns out and as i will discuss the fed has other powers which is to lend out money directly okay well to go back into history in the 19th and early 20th centuries in the united states there were repeated banking crises these occurred every five years every 10 years every 20 years in different ind with different degrees of severity then finally finally at long last in the 1930s the united states government finally took decisive action to prevent the occurrence of bank runs so there were at that time it created established a monetary and financial system a monetary and financial system with four lines of defense so the first line of defense was bank regulations and typically there was capital addiction sweet requirements as a second line of defense if that fails the fed can directly loan money to banks and that's effective in the case of a liquidity crisis or in a bank panic and then there's also a third and fourth line of defense deposit insurance deposit insurance means the people even in a failing bank have no special reason to take their money out so there will not be no bank panic in the first place and then there's a final line of defense and that line of defense was also important although i'm not sure it was i don't think it was ever actually used that is if a bank should fail then the government automatically has legal standing as the issuer of deposit insurance the federal deposit insurance corporation becomes the automatic holder of the defaulting bank it becomes the automatic caretaker and as a result the government then can take over the bank and conduct an orderly disposition of its assets so these four lines of defense mean that if the formal banking sector dominates financial markets no major liquidity uh problem is going to arise but something happened we had the system in effect it worked but then over the past 30 years there's been a huge growth in a shadow banking system what are shadow banks shadow banks are financial intermediaries that behave as if they were a bank but technically are not what do these they do these entities borrow short very much like taking in bank deposits but then hold long-term portfolios so this whole shadow banking sectors with trillions of dollars worth of assets had fewer none of the four lines of defense and and furthermore since the 1970s the system of finance had greatly changed in two otherwise and i'll name them just briefly first it had become common for the originators of loans to subsequently securitize them and sell off the different tranches of the payments of those loans and second people had also discovered that they could buy derivatives that would protect them against risk on those securitized loans so let's continue as long as there were confidence there were no problems these markets were liquid but as soon as we lost confidence institutions like hedge funds bank holding companies and investment banks have been unable to borrow the funds they need and they're suspicious of lending to the shadow banking system and they also lack the capital to do so so what should we do about it okay so here bob and i offer some suggestions based on our analysis regarding the role of animal spirits so our analysis so far explains how we got into the current crisis our previous unwarranted confidence has disappeared suddenly stories have gone from the wonders of homeownership to stories about snake oil houses and their snake oil mortgages the shadow banking system which depends on borrowing short and lending long is now threatened in this crisis so our view is consistent with the economic philosophy that's responsible for the setup of the federal reserve and also the employment act of 1946 we believe that the government and or the central bank have a responsibility for maintaining the macroeconomic conditions that underlie a healthy capitalism what does that mean on the one hand that means that aggregate demand should be maintained at a level close to full employment but such aggregate dem such an aggregate demand target is not sufficient in the current collapse why because it's not just a decline in aggregate demand that has occurred it's also a loss in confidence and there's a there is a view there is a view that all we need to do now is to give banks enough capital so they do not go bankrupt but that view is not even wrong so remember the shadow banking system and securitizations and derivatives were serving a function in the economy that was the way in which much of the economy's cr credit was being generated it was playing a big role and we were being very prosperous what happened is the originators of the loans would initiate them then they would not hold the loans themselves but instead they would pass them on to someone else to be securitized but with the lost in confidence the trust in the system collapsed and it cannot be put together again so it's a case of humpty dumpty so there's an english nursery run which you may all know but i'll go over it humpty dumpty sat on a wall humpty dumpty had a great fall now who was humpty dumpty humpty dumpty in fact in the original was an was it was a riddle and the question was who was humpty dumpty and the answer was humpty dumpty was an egg so let's conti continue um so uh so who was humpty dumpty humpty dumpty was an egg and because he was an egg he was fragile so when he fell it turns out this is the end of the rhyme all the king's horses and all the king's men could not put humpty dumpty back together again so what happens our story is the previous financial system depended on confidence that confidence was fragile and there's been a collapse in the credit system in the united states and in much of the west of the world so an indica let me just give you one indicator of that so every economist economists have their own pet statistics ones that they like and ones that they don't like so uh bob and i for if we want to look at credit i think our favorite uh indicator of what's happening to credit is commercial paper maybe that i don't know that that's a particularly good one but that's our choice and it said the commercial paper this is not quite correct but it said it anyway the commercial paper is what businesses use to finance their inventories and to finance their payments out of current wages it's sort of what they're supposed to use to finance their current operations since july 2007 gdp in nominal terms has gone up just a little bit but financial but commercial paper has fallen by more than 25 that is lot that's sufficient to mean that we really are we really are in the middle of a credit crisis so it's our conclusion that's the role of the government not just to shore up the banks to see that they do not go bankrupt but to see that the credit system is operating providing liquidity in such a dynamic crisis was in fact the original goal in the creation of the federal reserve when a banking crisis occurred the federal reserve was supposed to be the lender of the last resort and that's exactly what bob and i think the fed should do now so what's our recommendation for the united states our recommendations for the united states is the following that the united the government established two intermediate targets one target is the standard demand target what should that do that should aim to obtain full employment provided credit markets are working tolerably well this should be the basis for the conduct of normal monetary and fiscal policy but then in addition there should be another target there should be a credit target credit should be targeted at the level necessary to obtain full employment by a credit charge of course we do not mean some specific uh numerical measure we mean generally that loans that would be naturally granted when the economy is at full employment will be available so think about an entrepreneur a producer of goods who wants to buy get commercial credit and who produce not a snake oil product but the good product that's going to cure your ills and really that you find useful that person should be able to get credit uh should be able to cr get credit um so um above all and then above all in addition to this the government must see that the major banks are solvent and able to land okay so i think i'm going to reserve for the question period um i'm going to reserve for the question period what um the three methods to achieve the credit target so i'm going to skip that i think that's actually an interesting part of the talk but i'll skip it for now and maybe someone will kindly ask me that question okay so let's summarize summarize our recommendation is that there should be two targets the first target is the usual monetary fiscal target which is projected to reach full employment in the absence of a credit crunch the second target is the level of credit that would be associated with full employment income and these targets should be achieved by the use of the three methods who's that i skipped when i skipped these four pages okay okay um so why does this make a difference okay okay so why do we need such targets it seems to me that that this is we're just saying the obvious often when you listen to economic policy talks uh people seem to say what's just the obvious a friend of mine who was actually very high in the government once said he he never went to a meeting uh where uh either the issue at hand had not already been decided uh at the meeting or it was not up to the uh meeting to decide it that things were always decided elsewhere i think that's because so the question is why do we need such targets okay and uh why is this some a uh why is this a concept that people need you know economists don't we i think we we for the most part don't need this but the public needs it and i think it's needed politically so there are two reasons first of all the government itself needs to be realistic about what needs to be done so let's go back to the united states in the great depression both presidents hoover and roosevelt they had both many pragmatic schemes to put people back to work and to keep the credit markets from falling apart both hoover and roosevelt they were very good pragmatic people hoover is considered very bad but actually when you read the history is a very good person actually and he was an engineer too but because both of them because they were operating without change in theory they did not know how much to target they didn't have sufficient confidence to know how far they were they needed to go and so their operations were an order of magnitude short in fact unemployment in the united states only fell 10 to below 10 considerably after the start of world war ii in europe so just think about it the most important decision on in almost any journey is where you want to go and you know it's really amazing that a human ingenuity is really uh amazing if you really want to do something if you really want to go someplace then it's really truly amazing how how uh how able people are to actually meet their goals so that if we set this goal we say really this is what we want to do we need to get credit credit back where it should be we need to get aggregate demand back to where it should be then in fact we can find some ingenious method to do so and furthermore we just shouldn't leave lead uh leave our target um alone we should just try to get there now there's a second reason why these targets are important so i think we there will be political difficulties with any plan that is being devised any plan as indicated by my analysis here is going to be expensive and there's going to be massive sticker shock and there already is massive sticker shock amongst both the public and the congress so the turk targets approach is necessary it's necessary to legitimate the government's plan of action the two targets approach then comes from the rationale that achieving full employment should be the first goal of macroeconomic policy as stated in the employment act of 1946. okay okay so that's the macro economic problems we'll now come to another problem which is the micro economic problems or i think these are micro economic problems which are so big that they actually play it themselves out and are playing themselves out at a macro economic goal so this is the playpen problem and this is the macro microeconomic lesson so the playpen problem comes from the life of toddlers okay so if you put your toddler in the playpen you don't have to watch them very much but if you let your toddler out of the playpen you need to watch what she does and the same is true of financial markets supposing you deregulate financial markets on the one hand for example this is just an example supposing you allow derivatives that you did not allow before and you allow there to be a lot of them then you need additional regulation to see that the markets do not get out of control similarly if you've got your child out of the playpen that is if you give her the freedom to wander about the house then you need to watch her while the rhetoric that we hear about deregulation always misses that point says we either need more deregulation or we need less deregulation the view that deregulation should go in only one direction fails to appreciate the soft snake oil underbelly of capitalism if you allow markets more freedom in one direction then you also need to regulate them more in another and that's one of the major factors that results in in manias and panics so what's our major message here our major message here is then the capitalism does work but the problem sometimes is that it may work all too well and then it needs to be curved at least curved a little and curved sensibly okay so that's and i i i may come back and there's stuff that i've skipped and uh fill in there thank you thank you very much we indeed have time for some question one of all of the questions will be on on this target so sooner or later we'll come but i'm sure will be others so from the floor so let me take a few of them here please and another one over there so someone will be okay this does this is a translation it's not it's not working no it's not working just break the cycle because we have a technology um i enjoyed that and i agreed with most of what you said but i'm i suffer from regarding economics as difficult and i regard economic policy as difficult let me take the example of the engineering sector in northern italy metal mechanical orders have fallen by between 40 and 60 over this year in this sector um credit is a real problem because clients don't pay because they don't have money yes that implies quite correctly as you say that there's a problem of financing in the sector one needs more money firms need more money but at the same because they're not getting paid but at the same time they're much greater risks so if you're going to ask the banks as the italian government does to lend more the bank said this is not commercial given the riskiness of a lot of the enterprises in the current situation um so in the end i suppose i become ultra keynesian in this case i don't think monetary policy is going to be the real answer it's got to be the consumer or firms through investment to sustain the economy because until industry is profitable then banks cannot be asked to uh and one final comment i thought you're going to and i thought this would you want me to answer no no no just let me just make a quick comment because you don't need to answer this okay i thought i thought in your book as well you should have talked more of joan robinson when you talk about animal spirits that's not just canes okay good well maybe i should okay i'll have to go back and look at john robinson um okay it was actually it actually was indirectly through joan robinson and through a student of hers that i that actually we came to this so i you're exactly right okay um i think that that you were talking about the credit problems it seems to me that uh what we need is we also need a fiscal stimulus so that the the firms the engineering firms in northern italy know that they have enough orders and so that the banks can be confident that they have enough orders so that's why we need both things we if we just deal this with this is a credit crisis we're we're not going to work it's not going to work if we just deal this with this as an aggregate demand crisis it's not going to work we need to deal with both problems and then that's that's i think and you need to deal both both problems simultaneously it is in english your question please maybe they could ask their questions in italian and english well later yes of course um solve this problem i'll try to say everything in english because um i graduate in economics and my i used to help myself with history because my favorite economist is john keynes that i love econom political economy for john keynes and first thing i want to say that one of the most important objectives of economy is full employment and i remember when i was in university i read on a book about john kennedy albright about the employment act of 1946 and so i want to make this question i want to talk about this crisis and about the globalization i think that in this period in this age there is a totally fate in globalization and what of free markets could regulate everything about employment and other things like that i think that after this crisis the economic policy of europe was i do it to make a strictly a short speak they made the wrong economic policy because president obama asked to germany to france into italy to make to ex to make a more uh public expenditure and to get lower taxes for middle and poor class for uh making consumes uh grow up uh the and then the the enterprises the companies have uh the famous faith that john cain has said of animal spirits then they get investments so i think that this is wrong because uh this economic crisis is paid by the workers by the poor people because i remember during 1929 cries the neoclassical economies said that in the long period everything will get okay and john cain has said in the long period we are all dead in the long period so i think that economic policy is wrong and what do you think about the future because with all this faith of private sector the wages of the workers are always lower and there were no future because they cut the public money for public expenditure and and and economic get worse consumes and everything like grazia okay i think i agree with you i think that the most important thing i think at the moment is the short run that that that this is really um our priority our economic priorities should be to try to get the economy back to full employment and uh i think that that maybe in doing so we're not going to do things exactly optimally um but i think i think that's i think in this case we should be willing to pay that cost uh i'm a little bit worried uh i'm a little bit worried as jim heckman was talking about uh this morning that that we may initiate some very bad policies when we do this so we shouldn't just look at the short run but but i think this the short full employment is really where we should aim and that should be our our first priority and then we should also listen to the gym too can you hear me can you hear me now can you hear the translation wonderful thank you i married an englishman but nonetheless i think it will take centuries for me to be able to put a question in english well first of all thank you very much for being here i have one question to pose to you um hobbs uh spoke about animal spirit when he said homo homini lupus so we are all wolves to each other perhaps in economics and in politics this may be true but i don't think this is always true i'm not sufficiently pessimistic to believe so i think nonetheless that this is still the case in the area of economic of economy so my question is this on the one hand this kind of free animal spirits in the worst sense in totalitarian rules has directly led to a full failure in wild capitalism every 50 years or so the world gets into troubles into a very severe crisis also because secondary needs emerge and the market tries to grasp them and here i come at last to my question my question is do you believe that it's fair to say that the increasing legitimization of rationalization through good governments may be a solution may be a way to reduce this animal attitude in economics thank you i think we may have another question i can see one person looking for the microphone down the hall thank you um i'd like to ask you an opinion about the amount of money supply in the u.s and in europe what are going to be in your opinion the bailout programs to reduce the amount of money and do you believe that this amount of money supplied will result in hyperinflation and if so how will this happen and then one more question if i may don't you believe that perhaps the only way out of this crisis would be to open a pan-american market a joint american european market don't you think that this may be the only healthy way out of the crisis and by the way in 1341 there was the crisis of the republic of venice i think analyzing that would be helpful for all of us thank you uh sorry i don't have the translations i'm sorry italiano okay so that's a very good question um actually there is um krugman's column discusses that in in uh today's new york times but but actually um i think here what we're seeing is we're seeing an error that that has been made in standard macroeconomics so standard macroeconomics uh had no role for financial markets basically insofar as you knew the demand and supply for money that was all you needed to to know and that's that's sort of standard keynes it's also standard milton friedman but there's papers by blinder and bernanke in which the interest rate is set not by in the demand for supply of money but just set by the demand for and supply for loanable funds and so it's really the financial markets which determine interest rates okay so that's the technical answer to this and i think there's a whole i think there's a whole new area for macroeconomics which is to be to be explored here okay so that's item one second of all the practical question is how do you deal with how do you how do you deal with this um okay first of all i agree that what with what you say that this is a potential problem so the fed currently has increased the amount of money on its balance sheets by 1.5 trillion dollars which is beginning to be a lot of money but how do but the thing is uh the banks seem to be not loaning this out and so that's the problem and so as soon as the economy begins to recover as soon as we get back from the high unemployment that we get then exactly what the what what we should do is we should retract and we should stop making these loans so insofar as we've made increased loans now we should then make decreased uh we should have decreased loans then and we cannot it seems to me that we can uh the reason that we get uh we get inflation is because we have low unemployment as long as we have high unemployment we're going to get uh if not deflation we're going to get very low inflation so i'm not worried i'm the thing is you should my principle is i worry about everything and we should worry about this problem because we could be wrong but i think the standard answer to this is probably not okay so let's hope we can again have questions in italian uh well i i think i'm going to ask you okay the famous question the one on the on the on the way to achieve this okay i'm glad you asked me that question so uh tito has asked tito has asked me uh so what are the uh methods i said there are three methods to um uh whereby the government can expand credit um so the first and i i think when we do this we'll see some of the ways out of the current crisis and how we can deal with the credit crisis so in the first thing the fed can do expansionary lending by a variety of programs and which will increase the supply of credit and so far the fed's actually been very inventive in engaging in such policies and as i said it's increased the assets on its balance sheet by 1.5 trillion dollars so which is beginning to be a lot of money so the most inventive of these programs is something called tolf or the term asset-backed uh securities loan facility t-a-l-f now the first offering on toll illustrates how it can work powerfully and uh indicates how ingenious um financial planning can in fact get us out of this crisis just as it's gotten into it so let me tell you how it works so let's take the first offering on it in this offering what the fed did was it offered 200 billion dollars of loans of one-year maturity against a pool of collateral such as new car loans and those new car loans had to be uh triple rated rated aaa okay so what did what did it look like the treasury compute contributed a 20 billion dollar junior trash of the 200 billion okay so what does that mean that means that the treasury takes the first 20 billion dollars of loss that so the fed's 180 billion dollars is fairly safe what is it safe it's safe enough it's safe enough that the fed is legally empowered to make such a loan so now let's so now i've given you the details which are probably too complicated to understand so let me now explain why this scheme accomplishes three goals and then you'll understand what i said before so first it gives them powerful incentive for banks to make new loans the most the banks can lose if what they're going to do is the banks are going to take out these loans then they're going to put it take a small haircut and it's going to they're going to put it to the fed and then the fed is going to loan them back the money okay now current spreads between treasury bills and the types of loans that would go into the collateral pool should more than compensate for the potential losses that the banks might take if anything goes if if these bank loans don't pay off so let's suppose the current uh spread is something like five percent between treasury between treasury bills and what what the banks are getting they're getting a lot of money okay that's one second this is the key point the toff renders the fed's portion of the collateral sufficiently safe so the fed is only allowed to loan money in so far as it's safe and in is going to be there and it's going to be sufficiently safe because the fed because the treasury is putting up the initial 20 billion dollars of loss and so that means that probably the fed won't take any loss at all and then the third thing here's the key point the treasury's money can go much farther than if they were buying the troubled assets outright so let me give you an example with treasury taking up 10 percent of the collateral a 100 billion dollar contribution by the fed by the treasury could support a trillion dollars worth of new credit so that what's in scarce supply is the treasury money that's what we have only so much money of because the congress is only willing to give so much money to the treasury to for such purposes as uh getting out of the crisis so um so the story is that such order of magnitude of impact on credit is just what's needed to replace the humpty dumpty and we see that schemes such as tolf are available and in fact are playing a key role in the current obama financial plan more generally what we see is if we all put our thinking caps on that tall shows it that there are two sides to creative finance creative finance may have gotten us into this crisis but also its genius is capable of getting us out of it okay so that's method one method two we've already seen quite a bit of method two and that is the government can inject capital into the banks and if the government injects enough capital into banks then eventually the banks are gonna say what am i doing with all this money in my pocket i have to go and lend it out so in answer to your question about the companies here in northern italy these banks will then begin to lend out the money to those companies but i think you also need to get aggregate demand up for that too okay um and especially though we need that the injections have to be made to see that the banks are solvent that's the very first thing that we have to do is that we have to see that we don't get bank collapses which we can't do okay and then the third method is if all of this fails then the government can use government-sponsored enterprises to make direct loans now that to the people in the united states that seems to be a um a radical step but in fact the government's already doing that uh to a great measure so the government now is already lend making intervening in the mortgage markets and uh through loans to fannie mae and freddie mac which are semi federal government agencies semi government semi-private agencies that insure people's basically insure people's loans and so the government is already engaging in this and so we could engage in more of that i think that um so now i'm going to give you you'd give a general statement uh and and this i think is should be the way the government should be looking at this and the way the public should be looking at this so i think we should be taking a cat in the hat approach to this crisis um the cat in hat is a book by dr seuss about a cat who goes into some kid's house when is when their parents are absent and makes a mess of it and his mess of it maybe i shouldn't have said that but his mess of it is the following he says first we're going to do a and then he makes a mess and then we're going to do b and then he makes a mess and then we're going to do c and then he makes a mess and the parents are away and the house is a mess and then finally he gets to z and he says we're going to do z and then all of a sudden he's cleaned up the whole house and the house is in order now the thing is i think that we should take this cat in the hat approach to the crisis that what we should do is we should not think that we have the problem solved at any moment what we should do is we should be doing plan whatever plan we're doing let's say plan c or plan d let's suppose we're now on plan d and uh if we're and what we should do is we should take the the i the idea that we're going to try this plan we're going to see if that works and if that doesn't work then we're going to go to plan e and this is this is there's something everybody needs to know this cat in the hat idea the public needs to know it because we we need to have patience with the government being able to take these plans until finally we get something that works the government needs to know it because it shouldn't settle on plan d and say plan d has worked and not think about the fact that we may have to go to more serious measures so we should be working we should now be doing plan on plan d let's hope it works i'm hoping it works uh but i don't think we should give up on the idea that maybe we're going to need some something very serious in the future we may have to go to further plans and we should be working on that now and there are actually many ways in which we should be working on that now one of the most important ways that we should be working on that now is a lot of the problem is the failure of bankruptcy law and bob and i we looked last summer into what bankrupt what bankruptcy law was in the united states and we talked to the leading bankruptcy lawyers and they said in a systemic crisis bankruptcy law is a mess because the people who have standing are the creditors not the government and so bankruptcy law needs to be changed and so the congress and the treasury need to be working on this now this should be something that people should be should be working on at night all night long to to get us a bankruptcy law that deals with systemic failure so that the government has an interest okay so anyway uh you asked me you kindly asked me about the three methods but the three methods goes into the cat in the hat that i think we should be taking a cat in the hat approach of this and we shouldn't say oh my god so it's we shouldn't be euphoric one minute and say the problem is cured and then the next minute think that there's a disaster is going to be we should say gee uh let's hope that the problem is cured but let's also be uh cautious about it we won't have to go down to plant p q r and so on well no especially if you were in this house with the cat in the hat who made it who destroyed the whole house but i think you raised more questions about this please yeah almost as simple is it okay first part there is a school of thought but i think it's increasing among many people that sort of at the underlying level much of the problem came about because real interest rates were very low and real interest rates were very low in large part because of the large chinese east asian oil exporter surpluses and then deficits having to absorb all that in the us so that was the low real interest rate which certainly exacerbated if not more housing etc but that then goes into a question if you buy that what was happening in parts was triggered by the bad paper coming out of the housing market your comment was well we got to get the banks to lend again yeah we got to get them rea with equity nobody questions that but the question then comes as long as people are still sending their keys back in the mail and and more foreclosures are coming there's nobody knows how much more the banks are going to have and you can't i think or so it said recapitalize the banks until you hit the bottom in the housing market and it's difficult if not impossible to say okay we're going to have the government go and put a floor under housing prices they could do things as they are to slow it down but many of the things i hear you saying it says to me clearly we want credit to expand we agree on all that but can you do it without the bottom in the housing market so that you get the toxic assets out okay so that's a good question okay i'm not sure i know the answer to these questions but i'll i'll try i fir i think first of all one question is the banks and whether we can get the banks to um whether we can get the banks to lend again and how much that's one method that was method two yeah okay so my view on this is the housing what happened in the housing market is very big but it's not the major part of the crisis my view of the major part of the crisis is is the um is the uh complex financial securities and it's it and and the collapse basically of a whole system of finance anyway so um so my view is we should work through the banks as much as possible um but the capitalization recapitalization of the banks is going to be a very expensive method of getting this credit and the fed seems to develop uh lots of methods these are these auction facilities the tof and so forth which are other methods of expanding credit which seem to be much more effective on at much lower cost do you agree you don't okay we'll talk about it later okay and also there will be other opportunities at this festival ultimately yes okay i have a question on financial market and potential and potential growth so over the last three decades a financial institution has been advocating advocating financial liberalization and there are also also estimates of the positive impact of this financial liberalization on growth and estimates differ but more or less they range around i mean between a quarter and a half a percentage point my question is do you think that this financial crisis this strong financial crisis had an effect on potential growth and you have any estimate of that and i didn't hear the last so i was asking whether you think this financial crisis we are observing now has an effect on the potential growth rate of the economy and if the answer is yes whether you think or what are the main reason against a possible natural nationalization of part of the banking system okay okay let's so thank you does it have an effect on the potential rate of growth i think i don't really have a good answer to that um it may well be that we overestimated the potential rate of growth because we were including these um we were including lots of investments that uh wouldn't have been made and if the economy were in natural full employment uh without this finance this financial um over extension so so that's my uh so i i think i think maybe we might expect going back that the potential rate of growth is a less a little bit less than what we've previously estimated thank you very much i think it has been fascinating but unfortunately we have to uh uh to close down now also because there is another event where we continue and resume the discussion we already had the sort of order and appetizer what we are going to talk about this evening with ann krueger on how to strengthen the international monetary system some of the topics that were raised today will be discussed again tomorrow as i said tomorrow will be the lecture by rachel cranton who has been contributing together with professor akerlov to the theory of identity we also will have the lecture by roland abu on group think which is also very important about the type of issues that we've been discussing today is it irrational to have this way of collective thinking or is it rational so many of the topics that we discussed today will be continued tomorrow and this evening so please be with us and thank you so much for your lecture thank you very much thank you thank you thank you