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Ed Phelps was awarded the Nobel Prize for Economics in 2006. He is co-chair of the Center on Society and Capitalism at Columbia University. He spoke with Global Economic Viewpoint editor Nathan Gardels from Beijing on Tuesday, Sept. 16.
By Ed PhelpsNathan Gardels: Barack Obama says the financial meltdown on Wall Street is "the most serious financial crisis since the Great Depression." John McCain insists the "fundamentals of our economy are strong" though threatened by Wall Street greed. Which is it?
Ed Phelps: This crisis is plenty scary -- much more than the savings and loan crisis around 1990.
Yet, it is still the case that the unemployment rate has risen only moderately. It’s up by less than two points since this mortgage-related crisis started. It only barely exceeds 6 percent. This is nothing compared with the deep slump we went into in the mid-70s -- no less the Great Depression.
The crisis in the 1970s was very frightening -- a huge decline in stock prices, rampant inflation, a stunning increase in oil prices and unemployment over 10 percent.
Gardels: On the financial level, in what ways is it like the panic that led to the Great Depression? In which ways is it not?
Phelps: The present crisis is brought about by a crash in housing prices that caught the banks with too little capital and too many shaky assets of uncertain value. In the 1930s, too, banks failed for somewhat similar reasons. But that had severe impacts on asset prices and investment activity while, so far, the present credit crunch has had, in historic perspective, only mild effects on stock prices and business investment.
Gardels: Is re-regulation of the kind on banks after the Great Depression now necessary with our new financial institutions? What is it that needs regulation the most?
Phelps: Regulation has to rein in the financial sector's leverage, and the federal government has to stop feeding the financial sector's addiction to housing. Hedge funds, venture capital and other business-oriented investment need to be left free.
Gardels: What does the crisis in the heart of the U.S. financial world mean for global capitalism?
Phelps: Global capitalism has been given a black eye because it didn't keep its eye on the ball -- it financed housing investment instead of business investment. Certainly now there will be punitive measures and public projects that are hit-and-miss in terms of correcting the excesses. But I hope that politicians will recognize that we shoot ourselves in the foot if we shut down the only system capable of generating the dynamism the U.S. has.
Gardels: Will this crisis be contained in the U.S., or will it spread worldwide to emerging markets as well?
Phelps: The damage to the emerging markets will be done by the worldwide rise in the uncertainty premium and the bad assets spread all around, which all too few banks and financial institutions have avoided.
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