Real economic risk appears to have decreased over time as global economies have become more advanced and diversified. But market risks appear to have increased due to innovative financial instruments with unexpected characteristics. Is financial innovation a good thing? EFF/KRF: We do not agree with the reading of the facts in this question. We know of no solid evidence that market risks have increased relative to the risks of real economic activity. Market volatility and the volatility of real economic activity were both extremely high in the great depression, and both declined thereafter. During the post WWII period, market volatility tends to increase during recessions, along with (and typically in advance of) the volatility of real economic activity. From 2002 to late 2007 the volatility of real activity was low and market volatility hit all time lows. With the subsequent onset of a severe recession, market volatility increased, along with uncertainty about future real economic activity. (Read the full entry)Â
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