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Around the world with Martin Wolf

The celebrated analyst holds forth on the euro crisis and prospects for the world's leading economies

Ambrose Bierce once said that war is God's way of teaching Americans geography. This quip can be updated to note that there is nothing like an economic crash to spur popular interest on the workings of markets and finance. As a result, while some economies are crashing, the celebrity of some economists is booming. One of these celebrated economists is Martin Wolf, the chief economics commentator at the Financial Times and surely one of the world's most influential columnists. A few days ago I spoke with him at a conference in Istanbul.

What aspects of the crisis surprised you?

Martin Wolf: How undercapitalized the financial institutions were. Many were taking enormous risks based on a capital base that was clearly inadequate. And they relied on a lot of "hot money"; shorter-term funds that were allocated to longer-term deals.

With the benefits of hindsight what were the most important mistakes you made in your analyses and writings?

MW: I was paying too much attention to the macro and not enough to the micro. I was analyzing aggregate flows and did not look closely enough at the inner workings of the financial institutions. I think of this as the most important mistake in my career. My other mistake was not to realize how weak and inadequate the controls and regulations on banks and other financial companies were.

What responsibility do journalists have in this crisis?

MW: We made many mistakes of omission. We should all have been far more aggressive and rigorous in our scrutiny of banks, regulators and so on. Another problem is that, in general, journalists don’t know much economics and finance.

But in this crisis economists did not have a stellar performance either. They failed to anticipate the crash and now they can't agree on how to deal with the situation. Who were the exceptions in terms of seeing ahead of others what was coming?

MW: Nouriel Roubini warned early on about the price bubbles and about the dangerous link between overvalued asset prices and high debt levels. Robert Shiller dissected better than anyone else what was happening in real estate and its explosive implications. And Raghuram Rajan alerted early on about the fragility of the financial sector and explained how it was becoming a threat to global stability. Paul Krugman was also prescient in some of his early warnings. But the list is short and in truth there aren't many more names that deserve to be included. It has become quite obvious to me that mainstream economics is useless to explain what happened or how to deal with this mess.

Yet, the heads of state are forced to react to the crisis even if the advice they get from top economists is of dubious quality. How do you rate the handling of the crisis by George W Bush, Barack Obama, Wen Jiabao and Angela Merkel?

MW: Obviously Bush gets a fail. To Obama and Wen Jiabao I give a pass. And to Merkel a pass as leader of Germany and a fail as a European leader.

Yet, Obama is fiercely criticized for his handling of the economy.

MW: Critics argue that the US recession should have been shorter and the recovery faster and more vigorous. But based on historical experience and objective analysis, it is uncontestable that the crisis that Obama inherited could have led to an even deeper recession than there was and probably even a severe depression. Obama's main achievement is that he was able to avoid this catastrophe. In fact today, the US economy is far ahead in terms of recovery since the crisis erupted than the other five largest advanced economies.

In this crisis, central bankers have become major players. Who are the world's best central bankers?

MW: Ben Bernanke, the governor of the US Federal Reserve

Who else?

MW: Bernanke saved the world in 2008-09, though he has been insufficiently aggressive since then and he missed the crisis beforehand. But he was the man with the historic responsibility: nobody else.

Paul Krugman argues that more expansionary monetary and fiscal policy would reduce unemployment in the US while Raghuram Rajan thinks that many of the jobs lost in the crisis are gone for good as they are caused by profound technological and structural changes. Who is right?

MW: Both. One is right for the short term and the other is right for the longer term. I agree with Krugman that the US can and should do more through public spending and monetary policy to boost employment. And I also agree with Rajan that technological change and other transformations will require active policy initiatives to create jobs in new sectors.

In 10 years what country will have the fastest growing economy, Spain or Italy?

MW: Spain.

And between China and India?

MW: India.

US or Germany?

MW: The US.

And as we're in Turkey, a country that has had a spectacular economic performance, how do you see the situation here?

MW: It is likely to blow up, with an externally driven crisis. Domestic savings are far too low and the current account deficit is far too big. Turkey's economic situation is unsustainable.

What about Europe?

MW: I see three scenarios: Federal Europe; status quo plus; and break up. The status quo will fail and lead either to status quo plus or a partial break up. Status quo plus includes clear plans to clean the banks largely at the expense of creditors plus economic adjustment across the euro zone, and not just on debtor countries, a more aggressive stance by the European Central Bank to stimulate demand, and abundant financing for the governments that implement the needed reforms. I know that this is far from an optimal approach but it might be the only path that is both politically acceptable and economically viable.

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