How did the world economy fall into such a deep hole? It is recovering, but painfully, and after a deep recession, despite unprecedented monetary and fiscal easing. Moreover, how likely is it that a balanced world economy will emerge from this force-feeding? The very fact that such drastic action has been necessary is terrifying. The fact that there is little room for a policy encore is yet more terrifying. Most terrifying of all is that this is not the first time in recent decades the world economy has had to be guided through a post-bubble collapse.

In his latest book – a successor to Valuing Wall Street, which appeared in time to help alert readers avoid the 2000 meltdown – Andrew Smithers of London-based Smithers & Co, provides an invaluable guide to past errors of analysis and policy.* He is a rare guide – a man with a deep understanding of economics and a lifetime’s experience of financial markets. His work helps to explain the stock-market bubble of the 1990s, the fiscal errors of Gordon Brown and the recent credit excess.

The big points of the book are four: first, asset markets are only “imperfectly efficient”; second, it is possible to value markets; third, huge positive deviations from fair value – bubbles – are economically devastating, particularly if associated with credit surges and underpricing of liquidity; and, finally, central banks should try to prick such bubbles. “We must be prepared to consider the possibility that periodic mild recessions are a necessary price for avoiding major ones.” I have been unwilling to accept this view. That is no longer true.

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From the FT:

Goodbye, Macroeconomics - Eli Noam

The travesty of the commons - Christopher Caldwell on the field of Nobel winner Elinor Ostrom

The free market is not up to the job of creating work - Mort Zuckerman on US unemployment

Countdown to the next crisis is already under way - Wolfgang Münchau

Down but not out - Krishna Guha on the dollar

Elsewhere:

Cognitive Dissonance and Global Macroeconomics - James Kwak on rhetoric and reality in the global imbalances debate, at Baseline Scenario

Escaping the state should cost Lloyds - Peter Thal Larsen, Reuters

Herbert Hoover and the start of the Great Depression - Lee E. Ohanian on history VOXEU

No L - James Hamilton on having avoided an ‘L-shaped’ recovery, at Econbrowser

Goldman Turns Into a Financial Frankenstein While the Fed Snoozes Away - Huffington Post

A reflection on the G20 (The question never asked to Mr Zoellick) - Biagio Bossone on the legitimacy of the G20 for small nations, at VOXEU

By Andrew Sheng and Michael Pomerleano

The national authorities and the international community should be commended for the speed of action taken to stop the spread of the financial crisis. To protect the financial system from the deflation in asset bubbles, the public sector has essentially guaranteed all deposits, rescued systemically important institutions, made large liquidity injections and brought interest rates to zero or near zero under a zero interest rate policy. Almost all systemically important central banks entered into ZIRP under emergency conditions at the same time.

But the polices adopted to combat the crisis are creating their own problems. In the medium term, the treatment may be as expensive as the crisis.

Continue reading "Zero interest rate policy: Treatment may be as expensive as the crisis"

From the FT:

Wolfgang Münchau: Making the case for a weaker dollar

Alan Rappeport: US trade gap unexpectedly narrows in August

Editorial comment: US jobs subsidies

Roger Altman: How to avoid greenback grief

John Authers: Manufactured surprises will keep stocks rolling

Elsewhere:

James Hamilton, Econbrowser: Will stimulating nominal aggregate demand solve our problems?

Brad Delong on the wisdom of more fiscal stimulus

Paul Krugman, NYT: The madness of the monetary hawks

James Kwak, Baseline Scenario: “What’s wrong with a phone call?” - How Wall Street influences Washington

Alan S. Blinder, VOX EU: 25 per cent of US jobs are offshorable

By Thomas Palley

Over the past year the global economy has experienced a massive contraction, the deepest since the Great Depression of the 1930s. But this spring, economists started talking of “green shoots” of recovery and that optimistic assessment quickly spread to Wall Street. More recently, on the anniversary of the Lehman Brothers crash, Ben Bernanke, Federal Reserve chairman, officially blessed this consensus by declaring the recession is “very likely over”. Continue reading "A second Great Depression is still possible"

By Masahiro Kawai and Michael Pomerleano

In a previous article in the Economists’ Forum, we expressed skepticism about the capacity of the Financial Stability Board to implement sound international financial stability regulatory architecture. We concluded that the prospects were more promising on the domestic front; this led to a discussion on creating a financial stability regulator at the national level.

The Obama administration has proposed that the Federal Reserve should become the overseer of financial stability in the US. The central bank would gain power to monitor risks across the financial system and sweeping authority to examine any firm that could threaten financial stability. The nation’s biggest and most interconnected firms would be subject to heightened oversight. Continue reading "Bolstering financial stability regulation"

By Andre Sapir

Imagine the US was facing the current crisis with the following situation: only 30 of its 50 states belong to the dollar area; most of the southern states are outside the dollar area and so is New York, home of the US financial centre; the seat of the US government is in Washington, but dollar area chairman Ben Bernanke operates from Pittsburgh and secretary Tim Geithner is mainly governor of Vermont, one of the smallest US states, with a population of roughly half a million.

Absurd? Yet this is exactly what the European Union looks like, with only 16 of its 27 member states belonging to the euro area; most of the eastern states and the UK, home of the EU financial centre, outside the euro area; the seat of the EU institutions in Brussels, but ECB president Jean-Claude Trichet operating from Frankfurt and Eurogroup chairman Jean-Claude Juncker mainly the prime minister of Luxembourg. Continue reading "How the EU could stop the global crisis becoming a European problem"

By Greg Fisher

The UK government’s policies towards the banks are inadequate. This is not surprising because the British government and both main political parties lack firm ideological foundations. Neoliberalism has failed.  However, the circumstances the banks find themselves in are best understood through the lens of game theory; their situation is analogous to the prisoners’ dilemma. Government policy ought to be guided accordingly, with a firmer hand on bank lending. Continue reading "The bankers’ dilemma"