Nobody home in Washington DC
Since the Obama administration took over on January 20, the US Treasury has effectively been out to lunch. As widely reported (see e.g. this account in the Financial Times), Sir Gus O’Donnell (as cabinet secretary the top UK civil servant) has attacked the “absolute madness’ of the US spoils system, where a new Federal administration replaces the entire top stratum of the civil service with new officials possessing the right political connections and leanings. Quite a few of these top officials need to be confirmed before they can start working. This can take months. Many of the new officials have no political, government or administrative experience and spend most of their first months in office trying to figure out where the washroom is instead of designing and implementing policy.
It is a system designed to produce protracted policy paralysis. Often this does not matter much. It may even be helpful to the greater good at times – “That government is best which governs least.” – but in times of war and deep economic crisis, when the world we thought we knew may be falling apart, it is not a bad idea to have a government that can both think and act. The current US administration neither thinks nor acts much, judging from the results.
The discussions around the family dinner table in the Buiter-Sibert household are about to become even more fascinating for the adults and even more mind-numbingly tedious for the children. My wife, Anne Sibert, has just been appointed an external member of the provisional Monetary Policy Committee of the Central Bank of Iceland (CBI). The five-member provisional MPC has three executive or internal members: CBI Governor Svein Harald Øygard, Deputy Governor Arnór Sighvatsson and Þórarinn G. Pétursson, the CBI´s Chief Economist, and two external experts, Anne Sibert and Gylfi Zoëga. This Monetary Policy Committee will operate on a provisional basis, with formal appointments for the next five years likely to be made following national elections in Iceland in April.
Iceland’s largest three internationally active banks collapsed during the autumn of 2008; its currency collapsed and tight capital and foreign exchange controls are now in place. That this was the likely outcome of Iceland’s unsustainable credit boom and banking sector over-expansion had been predicted in a paper by Anne Sibert and myself, written in April 2008 (for fruit flies, a shorter version can be found here).
The country now faces an extremely difficult and painful restoration of internal and external balance, with high and rising unemployment, declining activity and falling living standards. Even the best-designed and competently-implemented monetary and exchange rate policies cannot alter that sombre reality. But competence and courage can help avoid unnecessary, avoidable economic distress and dislocation, thus minimizing the economic cost and human suffering that are bound to follow what may well have been (relative to size of the underlying economy and population) the biggest banking boom and bust in history.
The reports on the evidence given by the Vice Chairman of the Federal Reserve Board, Don Kohn, to the Senate Banking Committee about the Fed’s role in the government’s rescue of AIG, have left me speechless and weak with rage. AIG wrote CDS, that is, it sold credit default swaps that provided the buyer of the CDS (including some of the world’s largest banks) with insurance against default on bonds and other credit instruments they held. Of course the insurance was only as good as the creditworthiness of the party writing the CDS. When it was uncovered during the late summer of 2008, that AIG had nurtured a little rogue, unregulated investment banking unit in its bosom, and that the level of the credit risk it had insured was well beyond its means, the AIG counterparties, that is, the buyers of the CDS, were caught with their pants down.
The Bank of England today cut Bank Rate by 50 basis points to 0.50% and announced the start of its quantitative easing (QE) operations. Although no major damage was done through these decisions, both measures are disappointing and put the Bank further behind the curve.
The Monetary Policy Committee of the Bank of England I was privileged to be a ‘founder’ external member of during the years 1997-2000 contained, like its successor vintages of external and executive members, quite a strong representation of academic economists and other professional economists with serious technical training and backgrounds. This turned out to be a severe handicap when the central bank had to switch gears and change from being an inflation-targeting central bank under conditions of orderly financial markets to a financial stability-oriented central bank under conditions of widespread market illiquidity and funding illiquidity. Indeed, the typical graduate macroeconomics and monetary economics training received at Anglo-American universities during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding. It was a privately and socially costly waste of time and other resources.
Most mainstream macroeconomic theoretical innovations since the 1970s (the New Classical rational expectations revolution associated with such names as Robert E. Lucas Jr., Edward Prescott, Thomas Sargent, Robert Barro etc, and the New Keynesian theorizing of Michael Woodford and many others) have turned out to be self-referential, inward-looking distractions at best. Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works – let alone how the economy works during times of stress and financial instability. So the economics profession was caught unprepared when the crisis struck.