What was the underlying cause of the economic and financial crisis that began in the summer of 2007? I believe that it was an explosion of private sector credit, driven by excessively easy monetary policies and declining credit standards. This led, in turn, to various “imbalances”, including inexplicably high asset prices, sharp increases in the risk exposure of financial institutions, unprecedented spending excesses in many countries (consumption and private debt in the US and investment in China), global trade imbalances, and a marked shift of factors of production into sectors like construction likely to suffer from excess capacity going forward.

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