Monthly Archives: May 2009



By Roger E. A Farmer

In the FT’s Economists’ Forum, Benn Steil wrote a stimulating piece in which he argued that Keynes was wrong. His argument is that interpretations of Keynesian economics are all based on the assumption that wages and prices are sticky. But wages and prices are not sticky. Ergo – Keynes was wrong. Read more

Ingram Pinn illustration

Why has the European Union suffered so badly in a crisis that began in the US? The answer is to be found in four weaknesses: first, Germany, the EU’s biggest economy, is heavily dependent on foreign spending; second, several western European economies are suffering from post-bubble collapses in demand; third, parts of central and eastern Europe are also being forced to cut spending; and, fourth, European banks proved vulnerable to both the US crisis and to difficulties nearer home. Given these realities, recovery is likely to be slow and painful. Read more

By Stephen Grenville

Bill Poole’s suggestion for a market-based answer to too-big-to-fail is a useful contribution to the on-going debate, and this response is in the same spirit: we need debate to sort out how to fix a failed system.

The Poole proposal may be market-based, but it would introduce a substantial structural distortion by requiring banks to do something that is painfully expensive for them (this subordinated debt sits next to capital, and thus will be about as costly as capital). The market response would undermine its benefits. Even the old capital requirements (in effect much less than half the requirement of the Poole proposal) produced two market responses: evasion (as we have learned, capital ratios were actually much lower) and avoidance (the growth of the shadow banking sector, including institutions which turned out to be too-big-to-fail). Read more

Martin Wolf and Jeffrey Sachs are among those to have joined the FT’s debate on aid. Visit the Arena blog to read their contributions.

The UK has a strategic nightmare: it has a strong comparative advantage in the world’s most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest? Read more

By James W Dean and Richard G Lipsey

The enormous stimulus packages hastily put together by governments in most large economies encounter two sorts of criticisms from many conservative economists. Both criticisms are wrong.

The first is that spending will either be hurried and wasteful, or that it won’t come on stream until employment has recovered, and will therefore be inflationary. Read more

Pinn illustration

Is the current crisis a watershed, with market-led globalisation, financial capitalism and western domination on the one side and protectionism, regulation and Asian predominance on the other? Or will historians judge it, instead, as an event caused by fools, signifying little? My own guess is that it will end up in between. It is neither a Great Depression, because the policy response has been so determined, nor capitalism’s 1989. Read more

By Michael Pomerleano

The consequences of the banking crisis will linger for a long time. In a recent seminal paper, The Aftermath of Financial Crises, (December 19, 2008) Carmen Reinhart and Kenneth Rogoff find that the outcome of severe financial crises share three characteristics. Read more

By Benn Steil

The Congressional Budget Office estimates that the US budget deficit will reach $1.85 trillion this year and $1.38 trillion in 2010, 13.1 per cent and 9.6 per cent of gross domestic product respectively. Much more worryingly, it projects deficits averaging more than $1 trillion a year for the next 10 years, which will raise the US public debt-to-GDP ratio to more than 80 per cent by 2019.

 Read more

Pinn illustration

“If we want things to stay as they are, things will have to change.” Thus wrote the Sicilian writer Giuseppe di Lampedusa, in The Leopard. This seems to me the guiding principle of the Obama presidency. To many Americans, he seems a flaming radical. To me, he is a pragmatic conservative, albeit one responding to extraordinary times. In his own way, Mr Obama is following the path trodden by Franklin Delano Roosevelt. Read more

In 2010, according to the European Commission’s latest forecasts, the UK government will be spending 52.4 per cent of gross domestic product and receiving just 38.7 per cent of GDP in revenue. It will, as a result, have a gigantic general government deficit of 13.8 per cent of GDP. Worse, the UK’s cyclically-adjusted deficit will be 12.2 per cent of GDP. These are numbers one would expect in a time of war. Read more


Did inflation targeting fail? Central banks have mostly escaped blame for the crisis. Do they deserve to do so?

Just over five years ago, Ben Bernanke, now chairman of the Federal Reserve, gave a speech on the “Great Moderation” – the declining volatility of inflation and output over the previous two decades. In this he emphasised the beneficial role of improved monetary policy. Central bankers felt proud of themselves. Pride went before a fall. Today, they are struggling with the deepest recession since the 1930s, a banking system on government life-support and the danger of deflation. How can it have gone so wrong? Read more

By Lucian Bebchuk

Should banks with large amounts of troubled assets be allowed to participate as managers or investors in funds set up under the US’s public-private investment programme? The way the scheme is currently designed not only permits such banks to take part, but encourages them to do so. Read more

By Michael Pomerleano and Ying Lin

Until recently, the international financial community was focused on the financial crisis in the US, while the European and Asian banking communities indulged in a “schadenfreude” at the misfortune of the US after years of envying their financial innovations. However, the recent Global Financial Stability Report from the IMF points out that the banking crisis is global. Martin’s recent article reviews the data (Fixing bankrupt systems is just the beginning).

In this context, it is instructive to analyze the condition of the various banking system in the world, and get a sense for the capital shortfalls. We estimate that the largest banking systems in the Europe have $2,438bn in Tier 1 capital and a capital shortfall of $3,397bn; In East Asia, the largest banking systems have $1,189bn in Tier 1 capital and a shortfall of $758bn.  The findings of this article are twofold. First, there is a global shortage of bank capital. Second, the largest share of bad assets belongs to European banks, and Europe has both the biggest capital shortfall and has made the least progress in restoring the banking system to health.

With Ying Lin’s invaluable assistance we analysed the banking data provided by Bankscope. There are three issues at least. The data is not as timely (it is from 2007) and not as comprehensive as one would expect. Second, due to differences in national regulatory regimes, as well as accounting and taxation, the data on capital, equity and non performing assets is not strictly comparable across countries. Third, not all the financial institutions report comprehensive data. Mostly state owned institutions do not report key variables such as assets, equity, non performing loans and reserves. Therefore, it took considerable effort to analyze the data. As a result the findings need to be interpreted with caution. Nevertheless the results are instructional. Read more