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A blind eye to the warning signs: andrew smithers, author of the road to recovery, on what needs to be done to avoid another financial crash.

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The Road to Recovery: How and Why Economic Policy Must Change

Andrew Smithers, [pounds sterling]18.99, Wiley

Economic theory let us down in the run-up to the financial crisis and it's letting us down now. The recovery has been weak and is not soundly based. In The Road to Recovery I explain how theory and practice need to change if we are to have a strong, sustainable recovery and avoid another crisis.

Financial crises occur when the level of debt becomes exorbitant and they are triggered by plummeting asset prices. This was the pattern in the Wall Street crash of 1929, the Tokyo stock market crash of 1990 and the worldwide crisis of 2008. The policy of central banks depends on a theory known as the "neoclassical consensus", which has no place for debt, asset prices--or even banks. It should come as no surprise, then, that economic theory was totally inadequate in helping them to understand the nature of the looming problem and that the policymakers who relied on this theory couldn't see the crisis coming and were therefore unable to prevent it or even mitigate its effects.

The excuse that "nobody warned us" won't wash. In our 2002 article in World Economics ("Stock markets and central bankers: the economic consequences of Alan Greenspan") Stephen Wright and I were among those who highlighted the dangers posed by debt and asset bubbles and the weakness of the economic theory, which was leading policymakers to ignore the signals.

Having failed us then, theory is failing us again. The blind spot this time is the widespread assumption that the current downturn is cyclical and so will disappear once...

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