The Magic of the Market

Martin Feldstein

Will the most dramatic interventions in financial markets since the Great Depression result in a long-term expansion of the role of government? Can America survive trillion-dollar deficits and restore growth? Will the need for closer policy coordination forge a more integrated Europe? What long-term effects will the financial crisis have on emerging markets?

Over the past two decades, the worlds of finance and economics were transformed. Trillion-dollar global markets sprung up on the back of techniques for converting loans, interest payments, default risk, and much else into new securities that could be chopped up, repackaged, and sold around the world in mind-boggling combinations.

A long boom accompanied these financial innovations. But innovation also entails unexpected consequences, including abuses and busts. The financial crisis of 2008 reflects this reality, and was particularly severe, obliging central banks to provide liquidity and governments to recapitalize banks. What started as a meltdown in the US mortgage market spilled into the rest of the economy, triggering global recession.

Fixing today’s financial and economic mess will not be easy. Some regulatory changes are no doubt in order. But governments, like generals, often fight the last war, and the greatest danger today is overregulation. For progress is driven by the market, not by governments. Like the future itself, market innovation can never be made completely safe. If we are unwilling to accept risks, we will end up with stagnation, until markets are “rediscovered.” So how far can the balance between government and market shift without causing long-term economic damage?

Martin Feldstein, a former Chairman of the US President’s Council of Economic Advisors, President of America’s National Bureau of Economic Research, and currently Professor of Economics at Harvard University, has championed markets and fought government overreach throughout his distinguished career. During Ronald Reagan’s presidency, he helped manage a seismic shift in the world economy that initiated a quarter-century of strong global growth. In The Magic of the Market, written exclusively for Project Syndicate, Martin Feldstein discerns the sense – and exposes the nonsense – in today’s efforts to restore economic confidence.