Financial and Monetary Systems

Jean Pisani-Ferry on how to avoid stupid economic policymaking

A worker arrives at his office in the Canary Wharf business district in London February 26, 2014. London's financial services sector created 25 percent more jobs in February than a year ago, new data has shown, indicating the industry may be recovering from the restructuring and redundancies prompted by the financial crisis. After a strong January, the City hiring market showed no signs of slowing down last month, with 3,220 new jobs created, compared with 2,575 added in February 2013, according to financial services recruiter Astbury Marsden. The data suggests London's banks and financial services companies are returning to growth after slashing thousands of jobs in the face of a lengthy recession and a series of industry scandals that followed the financial crisis. Picture taken February 26, 2014. REUTERS/Eddie Keogh (BRITAIN - Tags: BUSINESS EMPLOYMENT TPX IMAGES OF THE DAY)  ATTENTION EDITORS: PICTURE 03 OF 25 FOR PACKAGE 'CITY OF LONDON - LIFE IN THE SQUARE MILE'. TO FIND ALL IMAGES SEARCH 'RECRUITER KEOGH' - RTR3FZ88

Jean Pisani-Ferry looks at the trade-offs involved in economic policymaking. Image: REUTERS/Eddie Keogh

Jean Pisani-Ferry
Professor, Hertie School of Governance in Berlin
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On August 30, 2013, the United States was about to launch air strikes on Syria, where more than a thousand civilians had died in a sarin gas attack perpetrated by the army of President Bashar al-Assad. But a few hours before the strikes were to commence, US President Barack Obama canceled them, surprising America’s allies. Instead, US diplomats engineered a deal with Russian President Vladimir Putin, whereby Russia would take responsibility for removing chemical weapons from Syria. The Syrian civil war went on, without the US becoming directly involved.

According to his recent interview with Jeffrey Goldberg in The Atlantic magazine, Obama is “very proud” of the moment when he considered, pondered, and, bucking his advisers, decided not to follow the “Washington playbook.” Not everybody applauded. According to Goldberg, then-Secretary of State Hillary Clinton privately complained that “if you say that you are going to strike, you have to strike.” But Obama refused to give priority to credibility: “Dropping bombs on someone to prove that you’re willing to drop bombs on someone,” he said, “is just about the worst reason to use force.”

Obama’s stance was in keeping with his now-famous foreign and security-policy mantra: “Don’t do stupid shit.” That dictum obviously alludes to his predecessor’s ill-judged decision to intervene in Iraq; but, more fundamentally, it expresses the way Obama approaches the balance of risks involved in major policy choices. Evidently, he does not hold concerns about credibility in high enough regard to let his hands be tied. The adequacy of the ultimate decision matters more to him than consistency with previous statements. Preserving freedom of choice in addressing a problem is more important than sending the right message. Judgment should not be obfuscated.

One thing that security policy and economic policy have in common is that they force governments to choose between minimizing immediate damages and safeguarding credibility. Economic debates also frequently place in opposition to one another those who emphasize unconstrained judgment and those who regard consistency as the gold standard of good policy.

This tradeoff was apparent in the summer of 2008, as the global financial crisis came to a head. After the US government had decided to bail out the investment bank Bear Stearns and to backstop the mortgage-finance agencies Fannie Mae and Freddie Mac, a congressional uproar led President George W. Bush’s administration to vow not to inject any public money into Lehman Brothers, another ailing investment bank. When it became clear that no private investor was willing to take over Lehman, the US Treasury lacked the resources needed to prevent a disaster. And disaster happened on September 15.

Similar tradeoffs repeatedly arose in the course of the euro crisis. Virtually all major episodes involved a choice between sticking to first principles and finding a way to fix a fast-developing crisis. But German Chancellor Angela Merkel’s own mantra was not quite the same as Obama’s. For her, unconventional action could be justified only by an imminent existential threat to the eurozone’s stability. This so-called ultima ratiodoctrine was repeatedly invoked to postpone decisions or reject early fixes.

It is hard to overestimate the significance of the dilemma between solving looming problems and avoiding moral hazard. It is pervasive in finance and arises often in monetary or fiscal decisions.

One school of thought, epitomized by the US government, considers moral hazard a valid concern but thinks it shouldn’t be overplayed: “Firehouses don’t cause fires,” as former Treasury secretary Tim Geithner put it (or, in the words of Federal Reserve Deputy Chair Stan Fischer, “condoms don’t cause sex”). Germany is the most prominent avatar of the other view: The long-term consequences of any decision should guide policy choices, and the expectation of insurance must not cause imprudence.

The existence of such differences in attitude should come as no surprise: The tradeoff is a real one, and policymakers may have different views, depending on their experience and time preference. The German school of thought, for example, emphasizes a policy system’s permanent rules of the game and tends to disregard the short-term costs of particular decisions. Another, perhaps deeper reason is power. For seven decades, the US government has been the ultimate fireman of the global system. Over that period, it has dealt with myriad crises worldwide and has learned to value discretion more than policy consistency.

So what can be done to avoid stupid economic policymaking? What matters most is the transparency of the decision-making process and its aftermath. Avoiding the rigidity of rules must not lead to arbitrariness. A robust and critical exchange of arguments, and – especially when urgency does not leave time for prior discussion – awareness that any decision will need to be explained and justified ex post are excellent antidotes to the abuse of discretionary powers. Debate and accountability can go a long way toward killing bad ideas.

Arguably, this is easier to apply to economic policymaking than to the battlefield. But even economic and financial decisions may require secrecy and speed. This is no reason for the relevant institutions not to organize an effective internal process or ensure properex post scrutiny. In this respect, much progress can still be made.

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