Kristin Forbes: Economists must bridge disciplines to find answers to financial crises

MIT Sloan Prof. Kristin Forbes

In 2009 when my colleagues at the National Bureau of Economic Research and I began planning a conference for a project we’re running on the global financial crisis, we were concerned that the material would no longer be timely when the symposium actually occurred. We needn’t have worried.

I’ve just returned from Washington, DC, where our symposium was held, and again financial crises were the topic of the day. Three years after cracks in the subprime mortgage market erupted into the most severe and synchronized global financial crisis and recession since the Great Depression, the world economy is once more in dangerous territory. What began as a singular sovereign debt problem in Greece has spread to the rest of Europe, and now threatens to become a second act to the first financial crisis. How did we get here? And how can we keep it from happening again?

This is where our project comes in. In 2008, in the midst of a worldwide credit squeeze, the collapse of blue-chip banks, and massive bailouts from the government, my colleagues – Jeffrey Frankel at Harvard’s Kennedy School and Charles Engel at the University of Wisconsin – and I noticed something disturbing. The world’s financial system was melting and yet leading international economists weren’t changing their long-standing research agendas. The reason was that in academia, you’re rewarded for specializing in one area and it pays to keep working on the same topic for years; furthermore, the heart of this crisis was at the nexus of corporate finance and international macroeconomics – two very different disciplines. Economists needed a nudge to branch out into new topics and learn new and different literatures.

So with the help of Marty Feldstein and Jim Poterba, the past and current presidents of the NBER, and a grant from the Sloan Foundation, we created a research project that bridged the research being done in both fields. We set up a competition calling for proposals for new research papers that helped explain the financial crisis: what caused it, why it spread so quickly, and what can be done to reduce vulnerability in the future. At the NBER we cannot recommend a specific policy; but we can analyze policies, and look at what works and what doesn’t. With this set of papers, our goal was to provide analysis that would help policymakers to better manage and reduce the likelihood of future financial crises.

We selected 14 projects, covering different aspects of the crisis. One paper, for instance, examines whether the approach of accumulating reserves – a strategy employed by a number of emerging market economies in the recent crisis – helped countries weather the downturn. Another paper investigates how global imbalances contributed to the crisis and were linked to problems in asset-backed securities and the housing market. Other papers looked at patterns of capital flows and the destabilizing role that contagion played in causing financial problems to spread.

Frank Warnock, of University of Virginia’s Darden School of Business, and I co-authored a paper that shows that a key factor driving capital flows is how domestic investors respond during crises. During the recent crisis when risks increased and foreigners stopped investing abroad, this did less damage in countries in which domestic investors compensated by selling foreign investments and bringing money home. This is applicable to the predicament in Greece: not only are foreigners not willing to invest, but domestic citizens are also sending money out. This makes the economic situation erode much faster.

We held an initial academic conference in June in Bretton Woods, and a more policy-focused symposium last week at the National Press Club. It was a chance to influence a very important community: our audience included central bankers, Treasury officials, investors, and other policymakers in town for the annual IMF-World Bank meetings. We held panel discussions with some of the paper’s authors, as well as policymakers, investors, and the press. The academics talked about what their research showed, while the investors and policy people talked about what they saw on the frontlines during the crisis and what they viewed as the greatest dangers today.

The discussion on the panels showed that we have a better understanding of the crisis now than when it initially erupted. But the discussion also showed the challenges in preventing the next crisis. Many of the steps that could reduce a country’s vulnerability—such as building reserves or adopting capital controls—have spillover effects on other countries that can make the world less stable. Preventing contagion from Greece to other countries today will be extremely difficult now that we have a better understanding of the many channels through which contagion can occur.

On a more positive note, the research papers and discussion at the symposium in Washington provide an intellectual foundation for future policy decisions. As the global economy is on the verge of the next crisis, these insights will be useful even sooner than expected.

Kristin Forbes is the Jerome and Dorothy Lemelson Professor of Management and Global Economics at MIT’s Sloan School of Management. She served as a Member of the White House’s Council of Economic Advisers from 2003 to 2005, where she was the youngest person to ever hold this position, and currently serves as a member of the Governor’s Council of Economic Advisers for the state of Massachusetts. 

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2 thoughts on “Kristin Forbes: Economists must bridge disciplines to find answers to financial crises

  1. Pingback: Economist's View: links for 2011-09-29

  2. A cross-disciplinary approach to research is absolutely the right way to go. One of the more obvious faults in academia, government and business is that specialisation without consideration for other fields and what expertise they bring to play leads to a tunnel vision. That is, “my particular area is fine therefore there is no problem that will affect it” which is a worrying trend especially given the significant roles many of these people have.

    Historically some of the key names in scientific development have been virtual polyglots; applying their knowledge and skillsets across different fields. One only has to look at the Founding Fathers of the US to recognise that these people were not simply specialists in any one area.

    Maybe Isaiah Berlin was wrong when he wrote of foxes and hedgehogs – hedgehogs may not know of one big thing!

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