By Martin Wolf Read more
By Lawrence Summers
While the financial crisis dominates current discussion on the US economy, questions regarding America’s future approach to globalisation are looming increasingly large.
Since the end of the second world war, American economic policy has supported an integrated global economy, stimulating development in poor countries, particularly in Asia, at unprecedented rates. Yet America’s commitment to internationalist economic policy is ever more in doubt. Even before the significant increases in unemployment likely in the months ahead, the indicators are all disturbing. Presidential candidates attack the North American Free Trade Agreement. The Colombian free trade agreement languishes. There are increasing attacks on foreign investment in the US, not to mention growing support for restrictive immigration policies.
To all of this the conventional wisdom has a well developed response, with four standard elements. First, the sceptic regarding trade deals or other internationalist policies is educated around the many benefits of trade, not just for exporters but also for consumers and the economy more generally. Read more
By Martin Wolf
As the latest World Economic Outlook from the International Monetary Fund remarks, “the world economy has entered new and precarious territory”. What are perhaps most remarkable are the contrasts between booming commodity prices and credit-market collapses and between buoyant growth in emerging economies and incipient recession in the US. So where are we? How did we get here? And what should we be doing? Read more
On March 17, Alan Greenspan wrote an article for the FT entitled “We will never have a perfect model of risk“, in which he argued: “We will never be able to anticipate all discontinuities in financial markets.” He concluded: “It is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation [do] not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.”
The article attracted a number of critical responses in this forum. For example, Paul de Grauwe wrote: “Greenspan’s article is a smokescreen to hide his own responsibility in making the financial crisis possible.” (Read all the responses.)
The article below is Mr Greenspan’s reply to those criticisms, written exclusively for the Economists’ Forum:
I am puzzled why the remarkably similar housing bubbles that emerged in more than two dozen countries between 2001 and 2006 are not seen to have a common cause. The dramatic fall in real long term interest rates statistically explains, and is the most likely major cause of, real estate capitalization rates that declined and converged across the globe. By 2006, long term interest rates for all developed and major developing economies declined to single digits, I believe for the first time ever.
Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence of monetary policy adding to the bubble is statistically very fragile. Paul De Grauwe depends on John Taylor’s counterfactual model simulations to conclude that the low funds rate was the source of the US housing bubble. Taylor (with whom I rarely disagree) and others derive their simulations from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. This suggests important missing variables. Counterfactuals from such flawed structures cannot form the basis for policy.
De Grauwe asserts that “signs of recovery” (I assume he means sustainable recovery) were evident before 2004 and hence the Federal Reserve should have started to tighten earlier. With inflation falling to quite low levels, that was not the way the pre-2004 period was experienced at the time. As late as June 2003, the Fed reported “conditions remained sluggish in most districts.” Moreover, low rates did not trigger “a massive credit . . . expansion.” Both the monetary base and M2 rose less than 5% in the subsequent year, scarcely tinder for a massive credit expansion. In fact, growth in total credit market debt owed by the U.S. financial sector declined from a 13% gain during 2001 to an 8% gain during 2004. Nonfinancial sector growth was less. Read more
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