By Heleen Mees
With anger directed towards bankers and rating agencies alike, this may be a good time to remember that low interest rates, rather than faulty mortgage products, are the root cause of the financial crisis and ensuing Great Recession.
I once quipped that to understand the origins of the financial crisis and recession, one should not read Michael Lewis’s The Big Short, but economist and Nobel Laureate Arthur Lewis’s Economic Development with Unlimited Supplies of Labor instead.
The Big Short provides an entertaining account of how low-income households in the US were force-fed unaffordable subprime mortgages, for the sole purpose of adding to the fortunes of Wall Street bankers. But if less subprime mortgages had been originated in the 2000s, the bubble (and bust) in the prime US mortgage market would arguably have been more extensive than it was. Read more
The financial crisis of 2009 is morphing into the fiscal anxieties of 2010. This is particularly true inside the eurozone. Spreads between rates of interest on Greek bonds and German bunds touched 3.86 percentage points in late January (see chart). The risk has emerged of a self-fulfilling confidence crisis that would have dire consequences for other vulnerable members. Much attention has focused on what might happen if the crisis were not resolved, with talk of bail-outs, defaults or even exits from the euro. But what would need to be done to resolve the crisis, without such a calamity? It is the demand, stupid. Read more
By Roger E.A. Farmer
For the past nine months I have been presenting some new ideas at academic conferences where economists have been grappling with the current financial crisis. Boston, Montreal, Amsterdam, London, Cleveland, Sydney, Atlanta … Only the venues change. The participants and the papers are always the same. Read more
By Vernon L. Smith and Steven Gjerstad
Financial and economic collapses in 2007-2008 and 1929-1930 followed unprecedented residential mortgage credit expansions. Both generated household balance sheet crises that were transmitted to banks as asset prices collapsed against fixed debts. Industry suffered from declining expenditures on housing and durable goods, and income fell when production and employment declined. Irving Fisher (1933) described this spiral in “The debt-deflation theory of great depressions.”
These developments impacted major categories of US expenditures. The chart shows percentage changes in expenditures on consumer non-durables and services (C), GDP, consumer durables (D), non-residential fixed investment (I), and housing (H). The change for each category is computed relative to its level at the start of the recession in Q4 2007. Read more
“As the last of the official Q3 data came in, the UK found itself in the unenviable position of being the only economy in the [Group of 20 leading economies] to remain in recession”. Thus did Consensus Forecasts summarise the UK’s plight. With the third-largest economic decline, after Japan and Italy, the most indebted households, the biggest fiscal deterioration and the greatest dependency on the financial sector among the Group of Seven leading high-income countries, the UK has suffered a huge economic shock.
Fortunately, the UK also possesses assets. Among these are: a government with the capacity to act; the ability to borrow in its own currency; a flexible exchange rate; a credible monetary regime; a modest initial level of public indebtedness; privileged access to the European market, the world’s biggest; a greater number of top-class universities than any country, apart from the US; and an economy that has shed its most vulnerable manufacturing activities. Read more
By Moritz Schularick and Alan M. Taylor
Are credit bubbles dangerous? Long-run historical data reveal that important changes have taken place in the financial system over the past decades, setting in train an unprecedented expansion in the role of credit in the macroeconomy. It is mishap of history that just at the time when credit mattered more than ever before, the reigning doctrine had sentenced it to playing no constructive role in central bank policies. Over the past 140 years, episodes of financial instability were often the result of “credit booms gone wrong”. Read more
Financial crises have devastating impacts on the public finances. The impact is also most severe where the pre-crisis excesses were greatest. Among members of the Group of Seven leading high-income countries, this means the bubble-infected US and UK. The question both countries confront is how soon and how far to tighten. Tightening will have to be substantial. But premature action could be a devastating error. Read more
By Thomas Palley
There is widespread recognition that the financial crisis which triggered the Great Recession was significantly due to financial excess, particularly in real estate lending. Now, policymakers are looking to reform the financial system in hope of avoiding future crises. But like the drunk who looks for his lost keys under the lamppost because that is where the light is, policymakers remain fixated on capital standards because that is what is already in place. Read more
By Ronald McKinnon
This is an updated version of Liquidity traps and the credit crunch, published in this forum on August 13, 2009
Since the onset of the credit crunch and global downturn, governments everywhere have responded to the shortfall in aggregate demand in a textbook Keynesian fashion. They have adopted fiscal stimuli: ramping up government expenditures and cutting taxes. Central banks followed the lead of the Federal Reserve by driving down short-term interest rates toward zero: almost exactly zero for overnight interbank rates in the US, Japan, and Canada, and generally less than 1 per cent in Europe into the autumn of this year. Read more