Crisis lessons from Irving Fisher. Enrique G. Mendoza, 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. “…in the great booms and depressions, each of the above named factors (over production, underconsumption, over capacity, price dislocation, over confidence, over investment, over saving etc.) has played a subordinate role as compared with two dominant factors, namely, over indebtedness to start with and deflation following soon after;… where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two.”
(Irving Fisher, 1933, p. 341) 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. The credit crunch may cause another great depression | vox - Res. 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. One of the most striking effects of the recent credit crunch is the huge surge in stock market volatility this has generated. Figure 1. Daily US implied stock market volatility Figure 2. The crisis of 2008: Structural lessons for and from economics | Foreign Policy: Why China's Currency Manipulation Doesn't Matter. 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. China is taking jobs from the American heartland. Blaming China for flailing U.S. manufacturing may be good domestic politics, but Geithner should hold his tongue. First, there is little evidence that a currency appreciation would have an effect on the U.S. economy -- let alone a positive one.
But sterilization is becoming problematic for the PBOC. It Was the Saving Glut? The paradox of thrift. Or, how come you used to say that if consumers don’t save more, it will wreck the economy, and now you say, if consumers do save more, it will wreck the economy? For the record, I am certainly among those who had been suggesting that America’s low saving rate was a significant problem. Let me begin by reviewing why I said that.
Recall that we can separate the various components of GDP (Y) in terms of goods and services purchased by consumers (C), government purchases (G), investment spending (I), and net exports (X): Subtracting C and G from both sides of the equation, The two terms on the right-hand side are the critical determinants of what kind of economic future we’ll have. From the equation above, if we want I + X to be bigger, we must want Y – C – G to be bigger as well. Private saving = Y – C – T. Notice I’m using the same symbol Y for both GDP and GDI, since the two are conceptually the same– every dollar of production necessarily generates a dollar of income. In other words, Opinion: Expect a Prolonged Slump - WSJ.com - Mozilla Firefox.
Mortgage Rates Likely Headed to 4.5%: Pimco's Gross - Economy * 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.
"I think at some point we're going to see a 4.5 percent mortgage rate and the 10-year Treasury rate capped at some level," he said. "When the Fed comes in to buy Treasurys that will be a big day. " Looking ahead at the government initiatives he expects to see in an announcement Tuesday, Gross said the government likely will inject more capital into needy banks only. That in turn would make commercial mortgage-backed securities an attractive investment, said Gross, head of the world's largest bond fund.
Bank Balance Sheet: Liquidity and Solvency, Par. 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. I'm intentionally mixing financial institutions. For commercial banks, the FDIC stopped the bank run by upping the FDIC insurance. For investment banks, the Fed provided the liquidity. Please think of this conceptually or I'll have to write 100 pages ... This post looks at a bank balance sheet and a liquidity crisis. In a subsequent post, I'll look at a solvency crisis and two possible solutions. A special hat tip to This American Life’s Alex Blumberg and NPR’s Adam Davidson who presents some of the same ideas (although I'm going to go further). Click on graph for larger image in new window. If you watch the Planet Money presentation, they explain the basics of a bank from a balance sheet perspective.
Capital is the amount of money investors put into the bank plus any retained earnings. The balance is: Assets = Capital + Liabilities Not all liabilities are the same. Economics and the crisis of 2008. 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. Notions such as the unqualified support for market deregulation or the dismissal of aggregate volatility now come through as frivolous fads, while abstractions from the institutional foundations of markets seem naïve.
These limitations call for self-analysis and reflection, and hopefully new research by young economists. Many of the roots of the crisis are apparent today, but most of us did not recognize them before the crisis. Free markets are not unregulated markets. No, Greenspan Was Not Right. Nick Rowe asks an interesting question: In 2003, Alan Greenspan argued that the Fed needed to set low interest rates to prevent falling into a liquidity trap and deflationary spiral...
In 2008, Greenspan's critics argue that those same low interest rates caused an asset bubble, which burst, causing the economy to fall into a liquidity trap and deflationary spiral. Is it possible that Greenspan and his critics were both right? Was the US economy doomed either way? My answer is no.
A deflationary spiral of the kind Nick describes is the result of a collapse in aggregate demand that creates expectations of further declines in nominal spending and ultimately the price level. These next three figures make my case. This figure shows that non-residential fixed investment was recovering in 2003 while employment remained flat. So Greenspan may have thought a deflationary spiral was around the corner in 2003, but the data indicates there was none in sight.
A New Depression? The Lessons of the 1930s | Jeff Frankels Weblo. Now that Janet Yellen is to be Chair of the US Federal Reserve Board, attention has turned to the candidate to succeed her as Vice Chair. Stanley Fischer would be the perfect choice. He has an ideal combination of all the desirable qualities, unique in the literal sense that nobody else has them. During his academic career, Fischer was one of the most accomplished scholars of monetary economics. Subsequently he served as Chief Economist of the World Bank, number two at the International Monetary Fund, and most recently Governor of the central bank of Israel. He was a star performer in each of these positions. One has trouble thinking of another economist-at least, since Keynes! Most relevantly, he has a lot of experience at crisis management, having been on the firing line at the IMF during the currency crises of the 1990s and again having responsibility for the economy of Israel during the Global Financial Crisis of 2008-09.
What are the implications for policy? References. Richard Rorty and the efficient markets debat. 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. Many of these studies show that there are market patterns, or anomalies, that seem inconsistent with the EMH. But how do we know these aren’t just coincidence? 1. 2. 1. Tags: Far From Over - Mozilla Firefox. The crisis and how to fix it: Part 1, causes | vox - Research-ba. 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? This pair of Vox columns addresses these questions, suggesting that the consensus view of the crisis’s causes and cures is flawed. (These columns are based on a talk at MIT’s 20 January 2009 Economics Alumni dinner in New York City.) The emerging consensus There is an emerging consensus on the causes of the crisis, which essentially rehashes an old list of complaints about potential excesses committed in the phase prior to the crisis.
And happen it did. References. REFLECTIONS ON A CRISIS Daniel Kahneman & Nassim Taleb, Mo. FOCUS ONLINE January 28, 2009 ARE BANKERS CHARLATANS? Sind Banker Scharlatane? (German Original) At blame for the financial crisis is the nature of man, say two renowned scientists: Nobel Prize winner Daniel Kahneman and bestselling author Nassim Taleb ( "The Black Swan").
By Ansgar Siemens, FOCUS online editor Two men sitting on the stage. Left. Kahneman explains why there are bubbles in the financial markets, even though everyone knows that they eventually burst. "Those responsible must go--today and not tomorrow" Taleb speaks out sharply against the bankers. It is nonsense to think that we can assess risks and thus protect against a crash. The early warning "Taleb had an early warning before the crisis. In autumn last year, the U.S. government instituted A dramatic bailout. Taleb calls for rigorous changes: nationalize banks--and abolish financial models. Buffett's Letter to Shareholders. By Bill McBride on 2/28/2009 08:27:00 AM Here is Buffett's Letter to Shareholders There are several interesting sections, but for housing I think the section on Clayton Homes (Buffett's manufactured home division) is especially interesting. Here is a brief excerpt (starts on page 10). First Buffett describes the lending debacle in the manufactured home industry in the 1997 to 2000 period: Clayton is the largest company in the manufactured home industry, delivering 27,499 units last year.
And now Buffett draws a parallel to the national housing bubble: [I]n an eerie rerun of that disaster, the same mistakes were repeated with conventional homes in the 2004-07 period: Lenders happily made loans that borrowers couldn’t repay out of their incomes, and borrowers just as happily signed up to meet those payments. The First Global Financial Crisis of the 21st Century Part II: J. Carmen M Reinhart, Andrew Felton, 23 February 2009 A second compilation of Vox columns dealing with the ongoing crisis, in three parts: How did the crisis spread around the world? How has the crisis upended traditional thinking about financial economics? How should we fix the economy and financial system? Edited by Andrew Felton and Carmen Reinhart Published 23 February 2009 Purchase in hardcopy from our UK distributor | Amazon US | Amazon UK Download the full PDF View individual papers Part II: June – December, 2008 Edited by Andrew Felton and Carmen Reinhart Preface Introduction Section 1: The spread of the crisis to the rest of the world Section 2: What is wrong with the traditional economic/financial viewpoint and models?
Section 3: The proper governmental response Chronology Glossary URL: www.voxeu.org Topics: Global crisis Tags: global financial crisis, VoxEu.org. The crisis and how to fix it: Part 2, solutions | vox - Research. My first column argued that the global financial crisis is really a run on all explicit and implicit forms of insurance, which is showing up as a freezing of credit markets at all but the shortest maturity.
In this column I discuss the consequences of this and what to do about it. Specifically, I argue that an efficient solution involves the government taking over the role of the insurance markets ravaged by Knightian uncertainty. A modern economy without financial insurance An economy with no financial insurance operates very differently from the standard modern economies we are accustomed to in the developed world. there is limited uncollateralised or long-term credit (since such loans always have an insurance built in through the possibility of default), the risk premium sky-rockets, economic agents hoard massive amount of resources for self-insurance and real investment purposes.
Mountains of investment-ready cash frozen by fear of the unknown Bringing the recession back to familiar turf. How We Were Ruined & What We Can Do - The New York Review of Boo. Empirical evidence on the monetary policy trilemma since 1970 | An $800 Billion Mistake.