12 February 2009 This column rehabilitates Irving Fisher’s debt-deflation theory to explain the current crisis. It suggests that fiscal stimulus will do little to prevent the crisis from becoming a protracted slump because the problem lies in finance. A cure will require reversing deflation and restarting the credit system. Economists read the literature about the Great Depression with deep intellectual curiosity and savour in particular the still ongoing debate about its causes and remedies. Keynesians argue that price and wage rigidities and a failure of aggregate demand were the main culprits for the biggest economic catastrophe recorded in modern history.
The crisis is shaping up to be a perfect storm – a huge surge in uncertainty that is generating a rapid slow-down in activity, a collapse of banking preventing many of the few remaining firms and consumers that want to invest from doing so, and a shift in the political landscape locking in the damage through protectionism and anti-competitive policies. Back in June 2008 I wrote a piece for VOXEU predicting a mild recession in 2009. Over the last few weeks the situation has become far worse, and I believe even these pessimistic predictions were too optimistic. I now believe Europe and the US will sink into a severe recession next year, with GDP contracting by 3% in 2009 and unemployment rising by about 3 million in both Europe and the US. This would be the worst recession since 1974/75.
With just a few words in his Senate confirmation hearing, U.S. Treasury Secretary Timothy Geithner resurrected the long-held American accusation that China's penchant for money management is hurting the U.S. economy. President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency, Geithner wrote in his prepared remarks. As the argument goes, an undervalued Chinese currency makes the country's exports artificially cheap, giving Chinese goods an unfair competitive edge. Reduced demand for American goods hurts U.S. manufacturers and limits the size of the U.S. job market.
An increasing number of observers are placing the origins of the current economic crisis with the saving glut explanation of global economic imbalances.
« What Are These Three Numbers? | Main | Kash Mansori on a home purchase tax credit » February 08, 2009
By CARMEN M. REINHART and KENNETH S. ROGOFF
Pimco's Gross on the Current Financial Crisis The shift in economic growth has most of the world's connected economies and their citizens in shock, says William Gross, Pimco co-chief investment officer/founder In addition to driving down mortgage rates and stimulating home-buying, the government's efforts also could include a move to cap Treasurys rates to encourage investors to take more risk, Gross said during a live interview on CNBC.
by Bill McBride on 4/26/2009 11:57:00 AM Note: I took some short cuts to make this simple - think of this conceptually .
The global crisis is a challenge to and an opportunity for the economics profession. Here one of the profession’s most innovative thinkers reflects on how and why economists failed to see the crisis coming, what they should tell governments to do about it, and what young economists should be working on to help us avoid future crises. The global crisis is also a critical opportunity for the discipline of economics – an opportunity to disabuse ourselves of notions we should not have so gullibly accepted.
Nick Rowe asks an interesting question:
We often hear the question “isn’t this economic crisis becoming as bad as the Great Depression?”
I use the efficient markets hypothesis in my research and in my blog. Once I started looking at the world through the EMH lens, I found it much easier to understand the relationship between policy and the financial markets—particularly in my research on the Depression. Here I’d like to do three things; indicate why I believe markets are more efficient than they seem, acknowledge that there are events that look like market inefficiency, and then argue that those perceived inefficiencies, even if real, don’t have the policy implications that many people assume they have. Last Sunday I discussed cognitive illusions, aspects of economic theory that are highly counter-intuitive. I regard the EMH as one such economic theory—strange, but (almost) true. Let’s start with all of the studies showing market inefficiency.
Floyd Norris writing in the NY Times reminds us that the problems in the U.S. financial sector are far from over: The loans went to borrowers who might never before have been allowed to borrow. When they found repayment difficult, they were permitted to refinance their loans, generating fees for the lenders and postponing the ultimate reckoning.
This is a financial crisis to remember. The financial losses are measured in trillions of dollars; elite financial institutions have fallen; fear and mistrust are widespread among investors and lenders; credit markets are not operating except for those with very short maturities; massive and unorthodox policy interventions are an every day occurrence; and we have been, and continue to be, on the verge of a global financial meltdown. How did we get into this situation? What should we do to get out of it and to prevent a relapse?