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THE ONGOING FINANCIAL CRISIS, with its devastating consequences for economics worldwide, has fundamentally altered public perceptions of financial markets. It has also triggered a renewed cycle of debate among economists regarding both the causes of the crisis and the benefits of the stimulus policies implemented to address it. Prominent economists have gone as far as claiming that the crisis has discredited basic tenets of dominant economic thinking, such as the efficient market hypothesis and the selfadjusting nature of markets.
Yet there seems to be general consensus that the regulator}' framework of the financial sector has been largely insufficient in keeping pace with financial innovation and the increasing importance of the shadow banking system. A series of counterproductive government policies since the 1980s permitted mismanagement in the American financial sector that produced the speculative excesses that led to the crisis. In a discussion with YER, Edmund Phelps, the 2006 Nobel Laureate in Economics and Director of the Center on Capitalism and Society at Columbia LTniversity, warns against the government's short-term focus on economic recoverv. He calls for a bold reform of economic institutions that would tackle the root causes of the crisis. He also presents his suggestions for government initiatives and effective regulation that will steer the financial sector back to serving the commercial sector and the economy at large.
YER: Do you believe thai the ongoing crisis is the greatest challenge the capitalist system has faced in its history ?
PHELPS: Even though it is not the worst crisis in terms of the usual "metrics" (unemployment rate, slowdown of GDP etc.), it is a very disturbing challenge because the behavior of the financial sector seems so reckless. There seems to be little thought to serving the economy in addition to just the businesses themselves.
YER: Do you think the economic crisis has come about mainly as a result of the ills of the financial sector, or is the magnitude of the crisis also explained by factors beyond the financial sector, both domestic and international?
PHELPS: Some non-business market forces did operate to get the speculative boom in housing started; the boom that is now unraveling could not have been the spontaneous...