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“Domino and Popcorn” in the Economic Crisis: IZA Tower Talk with Edward Lazear
On June 3, 2009, the 22nd IZA Tower talk was dedicated to the ongoing economic crisis. Edward P. Lazear (Stanford University), former Chairman of the U.S. Council of Economic Advisers under President Bush, delivered a first-hand account of the political debates and decision-making processes inside the U.S. government in the early days of the global crisis.

Lazear described the enormous pressure under which the former – as well as the current – U.S. administration had to contemplate different courses of action when it was clear that the domestic crisis would soon spread to economies around the world. He believed that the European economies have not yet reached the bottom of the recession. While a trend reversal is already on the horizon in the United States, Europe would eventually follow the same path, yet in a time-lagged fashion.

from less developed countries into the United States. This sent the wrong signal to market agents who, despite early warnings by the U.S. administration, pursued imprudent or too risky investments. In retrospect, the partial collapse of the U.S. real estate market and the banking sector was only a question of time, said Lazear. But the veracity and velocity of this breakdown had been underestimated by most experts for lack of historical precedent.
As to the primary cause of the crisis, Lazear explained that excessive subprime lending in the U.S. market promoted an irresponsible attitude towards money and the creation of highly speculative financial products. The bubble was aggravated by capital flows In a rather self-critical manner, Lazear admitted that his own initial assumptions had also turned out wrong. The idea behind the U.S. government intervention to rescue the first collapsing banks was to prevent a domino effect. In reality, however, the crisis did not unfold like falling dominoes. Lazear compared it to “popcorn in an overheated pan – you can remove the popped corn, but the rest will still pop.“ Instead, the former economic adviser said the U.S. government should have taken the heat from the pan by pumping money into the market. This mistake was not corrected until half a year later, in September 2008, when Wall Street had already gone up in the air like exploding popcorn. On the “verge of a Great Depression,” it was only the courageous recapitalization programs for the ailing banks that prevented matters from getting worse. Ultimately, in a historically unique situation, the government policy was marked by “responsibility and success,” said Lazear. The Obama Administration, as well as the Europeans, can now build upon this foundation and benefit from the action taken by the previous administration.

The Stanford economist also warned against protectionist tendencies that seem to resurface in the global economies. He claimed that free trade is an important prerequisite for a quick resolution of the current crisis. Likewise, governments should not give in to the increasingly popular calls for a return to state regulation. The current programs must expire once the economies have recovered. According to Lazear, it was not at all a lack of regulation that led to the crisis since the banking sector is comparably well-regulated. Lazear agreed with Hilmar Schneider, IZA Director of Labor Market Policy, that the crisis is a result collective failure, also on the part of the political entities that control the banking sector.

The U.S. recession will end in the second half of 2009, according to Lazear’s prediction. Germany and Europe, however, should be prepared to wait another year. The crisis will not “end the American era.” On the contrary, foreign investment in the U.S. is on the rise again, which Lazear saw as evidence that “the people are still convinced that the United States is the best place to invest.”