The great financial crash of 2008 was expected to lead to a fundamental re-thinking of macro-economics, perhaps leading to a profound shift in the mainstream approach to fiscal, monetary and international policy. That is what happened after the 1929 crash and the Great Depression, though it was not until 1936 that the outline of the new orthodoxy appeared in the shape of Keynes’ General Theory. It was another decade or more before a simplified version of Keynes was routinely taught in American university economics classes. The wheels of intellectual change, though profound in retrospect, can grind fairly slowly.
Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks. The “DSGE” (mainly New Keynesian) framework remains the basic workhorse, even though it singularly failed to predict the crash. Economists have been busy adding a more realistic financial sector to the structure of the model , but labour and product markets, the heart of the productive economy, remain largely untouched. Read more
The calmness of the financial markets in the face of the deteriorating Cyprus crisis in the past week has been remarkable. Although Cyprus is tiny enough to be completely overlooked in most circumstances, its economy and banking system have characteristics similar to other, much larger, eurozone countries. Cyprus is certainly at the extreme end, but an over-leveraged banking system, with insufficient capital and reliance on foreign funding, is familiar territory in the eurozone.
Cyprus is therefore, in some respects, a microcosm of the entire eurozone crisis, if a microcosm on steroids. The manner in which the crisis has been handled by the Eurogroup and the ECB will have demonstration effects on other economies, for good or ill.
At the time of writing, the outcome of this weekend’s negotiations remains uncertain. However, assuming that there is no catastrophic breakdown in the talks, leading to the exit of Cyprus from the euro area, the broad outline of the settlement seems to be taking shape. It is reported that the Cypriot government will accept a “bail in” of depositors in one or both of its troubled banks, allowing the release of eurozone financial support, while still keeping the government debt/GDP ratio under 150 per cent. Read more
The annual meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.
There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.
However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory. Read more
ECB headquarters in Frankfurt. Bloomberg
(Updated with comments, below) For those of us trying to follow the progression of the eurozone’s leaders towards their critical summit on Friday, it has been a fascinating but somewhat bewildering week. However, the critical point is that, so far, the game still seems to be taking place on a playing field mainly of the Germans’ choosing, so the inevitable concessions and bargains which are reached at the summit will still leave the final outcome lying well within their preferred territory. (See an earlier blog.)
What is basically under discussion is a tightening in the fiscal rules which will apply to, and indeed within, the member states, in exchange for a provision of a limited amount of liquidity to allow these countries to reach the point at which they can regain market access for their sovereign debt. With eurobonds now effectively ruled out, any permanent transfers of resources within the enhanced fiscal union are strictly limited in size and scope. However, if the settlement is to prove durable, Germany will need to give some ground in the coming hours. Angela Merkel, the German chancellor who is nothing if not an arch pragmatist, undoubtedly realises that. So where will the bargains be struck? Read more
The newly published IMF World Economic Outlook (WEO) for April 2011 is a particularly excellent document, even by the exalted standards of that publication. Since the credit crunch, the IMF has been given increased responsibilities for monitoring the world economy and for cajoling policy makers in the right direction, especially on issues which spill over from one economy to another. And they have improved the depth of their analysis to meet this task. Read more
When the Queen asked asked an academic at the LSE why the economics profession had failed to predict the credit crunch, she raised a topic which continues to resonate. In fact, the IMF’s watchdog criticised the organisation on exactly those grounds yesterday. Read more
There are two massive fixed exchange rate blocks operating in the world economy today, and both of them are facing severe strains and conflicts. Read more