A Time to Experiment

CAMBRIDGE – The world economy enters 2009 with more uncertainty (and anxiety) than at any time in recent memory. Although the financial crisis appears to be contained in the United States and Europe, its full repercussions will not be clear for some time. The advanced countries are in for the worst economic downturn since the Great Depression. But how long and deep will this recession be, and how badly will it affect emerging and developing nations?

We don’t have the answers to these questions, in part because the consequences will depend on what actions policymakers take. The right responses will ensure that the world economy can begin to recover by late 2009. Poor policy choices, on the other hand, will at best delay recovery and at worst do permanent damage. Here is a list of things to watch for.

Will the US response be “bold” enough? Barack Obama has promised that it will be, echoing at least part of Franklin D. Roosevelt’s famous call for “bold, persistent experimentation” at the height of the Great Depression in 1932. Obama has a first-rate group of economists on his side, which ensures that he will not do anything silly. But America’s circumstances are sufficiently exceptional that he will need advisers who are willing to try new, untested ideas – in other words, experimentation à la FDR.

In particular, he will need to go beyond Keynesian fiscal-stimulus policies to heal the deep wounds to economic confidence that lie at the root of the current crisis. So far, confidence-building measures have been limited to financial markets, through public guarantees, liquidity support, and capital injections.