U.S. President Barack Obama wipes his face as he speaks at a campaign event at Iowa State University in Ames, Iowa, August 28, 2012.  Larry Downing / Reuters

Republican vice-presidential candidate Paul Ryan in Dover. (Brian Snyder / Courtesy Reuters)

Menzie D. Chinn

In "The True Lessons of the Recession" (May/June 2012), Raghuram Rajan sketches a structuralist interpretation of the Great Recession's causes and aftermath and draws out the resulting policy implications. Although he gets much right about the causes of the crisis, the reforms he recommends for ending it are misguided. In an environment of insufficient demand, a strategy that relies solely on getting rid of regulations, investing in human capital, and spurring entrepreneurship is doomed to end in sorrow. These types of policies are better thought of as complements to, rather than substitutes for, aggressive tactics aimed at boosting demand.

As Rajan admits, the crisis was caused by a confluence of forces, most important among them an ill-conceived frenzy of financial deregulation. This deregulation swept away existing checks on banks and gave rise to the weapons of mass financial destruction that proliferated in the early years of this century, such as credit default swaps and collateralized debt obligations. Rajan holds politicians primarily responsible for these problems, since they promoted a culture of homeownership, backed Fannie Mae and Freddie Mac, the government-sponsored mortgage agencies, and defended the interests of Wall Street.

Yet more blame should go to the financial sector, which deployed lobbyists to plead the case for deregulation. Had the George W. Bush administration pursued an aggressive regulatory stance, it could have avoided -- or at least reduced -- the devastating bubbles in the housing sector and in asset-backed financial products. In fact, even minimal regulation would have been helpful. Instead, just as the challenges of bank lending were rising, James Gilleran, the administration's first head of the Office of Thrift Supervision, which was supposed to watch over savings banks, proudly cut 20 percent of his agency's work force. Likewise, the Federal Reserve under Alan Greenspan failed to crack down on predatory lending practices through its authority over bank holding companies.

Rajan asserts that because

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