concludes in a recent _World Economic Outlook_ that “policymakers should react more strongly to signs of increasing macrofinancial risk”, including responding to asset bubbles with stronger macroprudential regulation (International Monetary Fund 2009).

Second, it means that not only do countries have to worry about domestically generated risks, but they also have to worry about risks generated by developed-country crises. To some extent, this has always been the case, due to the smaller market size and export concentration of many developing countries. It’s often said that “when the United States sneezes, Mexico catches a cold”. In the latest crisis, however, the United States caught the flu, and the consequences are commensurately more serious for Mexico and other developing countries that are integrated with advanced economies. Mexico in particular has suffered its worst downturn since the 1930s, with GDP falling 7.1 percent in 2009 (World Bank 2010, 131-132). Developing countries will need to factor into their calculations the possibility of major crises that are not due to domestic mismanagement or even terms-of-trade shifts.

This has led some observers to argue that the prevalence of crises is growing. Ravi Kanbur wrote recently, for example, that “for developing countries, periodic crises are likely to be the ‘new normal’”, with “major country level shocks over which the country has no control” (Kanbur 2009). As a result, countries are likely to want to focus more on reducing vulnerability to external shocks and improving systems of social protection. On the former, some countries may to be attracted to mechanisms for reducing volatility of external capital flows (discussed below), although this will still leave them vulnerable to trade and other channels of transmission. On the social protection front, Kanbur argues that a leading lesson of the crisis is the need for improvements in this area. He argues that social protection needs to be a system, not just a set of components, and that it needs to be in place well before crises hit. While it is too late to put together such a system for this crisis, Kanbur argues that his must be a priority for the medium-term future. The system should be flexible, so that it is possible to scale it up rapidly during crises – and, equally important, to scale it down after the crisis to mitigate fiscal costs (Kanbur 2009).

A second change in mindset that is emerging is in the predominant conceptual model. It has become clear that the efficiency of markets cannot be taken for granted, even in case of thick, active markets like financial markets. Irrationality can persist for a long time, in the form of bubbles, and can have major macro consequences, even in relatively well-governed economies. Greater awareness of this fact will reduce the appeal of economic world views and policies that rely heavily on the infallibility of markets. In political economy terms, there is likely to be greater mistrust of such policies; unfortunately, this mistrust could block not only misguided policies but also muchneeded reforms.

There will also likely be greater recognition of the advances of the past 20 years in the field of behavioral economics. Behavioral finance is much better suited to explaining bubbles than are mathematically elegant neoclassical finance models, as Krugman has pointed out. But behavioral economics has implications that will be relevant to policy in a number of other fields besides 16