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Financial Innovation: Playing with Fire

Paul Krugman, a Nobel prize-winning economist-cum-polemicist, argues that it is difficult to think of any noteworthy financial breakthroughs that have benefited society in the past 25 years. Joseph Stiglitz, another Nobel laureate, has highlighted the fact that most financial innovation in the build-up to the financial crisis “was not directed at enhancing the ability of the financial sector to perform its social functions”. This debate – aimed primarily at market-based innovation – begs a simple question: is financial innovation good or bad? Like most things, the answer is dependent on context. Are credit cards bad? Or mortgages? It is true that some instruments—for example, highly leveraged ones—are inherently more dangerous than others. But even innovations created with the best intentions often look a lot like those that are now vilified…

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