Category: Baseline

Baseline Scenario, October 30, 2009

Yesterday morning I testified to a Joint Economic Committee of Congress hearing (update: that link may be fragile; here’s the JEC general page).  The session discussed the latest GDP numbers, the impact of the fiscal stimulus earlier this year, and whether we need further fiscal expansion of any kind.

I argued that a global recovery is underway and in the rest of the world will likely be stronger than the current official or private consensus forecast, but growth remains fragile in the United States because of problems in our financial sector.  While our situation today is quite different in key regards from that of Japan in the 1990s, the Japanese experience strongly suggests that fiscal stimulus is not an effective substitute for confronting financial sector problems head on (e.g., lack of capital, distorted incentives, skewed power structure). 

We are well into the adjustment process needed to bring us back to living within our means. Although such a process always involves an initial fall in real incomes, growth can resume quickly as the real exchange depreciates.  The idea that we necessarily are in a “new  normal” scenario with lower productivity growth seems far fetched, but continuing failure to deal effectively with the “too big to fail” banking syndrome delays and distorts our adjustment process – it also makes us horribly vulnerable to further collapses.

The fiscal stimulus enacted in early 2009 had a major positive impact, particularly as it was coordinated with other industrial countries – this prevented the global recession from being even deeper (disclosure: I testified to the need for a major fiscal stimulus in October 2008).  But a further broad stimulus at this time is not warranted and the first-time homebuyers tax credit should be phased out.  We should extend unemployment insurance and focus our future efforts on improving the skills of people with less education, e.g., through strengthening community colleges. 

Like all industrialized countries, we also need to look ahead to “fiscal consolidation” in order to stabilize our debt-GDP levels (and pay for the rising cost of Medicare).  The large contingent government liabilities implied by the existence – and potential collapse – of big banks are a major risk to medium-term outcomes.

My written testimony (with some small updates indicated) is below (pdf version).  This is now our revised Baseline Scenario. Continue reading “Baseline Scenario, October 30, 2009”

Where Are We Now? Five Point Summary

1. Financial markets have stabilized – largely because people believe that the government will not allow Citigroup to fail.  We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside.  How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view).  For more on how we got here, see the Frontline documentary that airs on Tuesday and Paul Solman’s explainer wrap up.

2. The real economy begins to bottom out, although unemployment will not peak for a while and could stay high for several years.  Longer term growth prospects remain uncertain – has consumer behavior really changed; if finance doesn’t drive growth, what will; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)? Continue reading “Where Are We Now? Five Point Summary”

Baseline Scenario, April 7, 2009

Baseline Scenario for 4/7/2009 (9am): Post-G20 Edition

Peter Boone, Simon Johnson, and James Kwak, copyright of the authors.

This long-overdue (and hopefully widely-awaited) version of our Baseline Scenario focuses largely on the United States, both because of the volume of activity in the U.S. in the last two months, and also because the U.S. will almost certainly have to be at the forefront of any global economic recovery, especially given the wait-and-see attitude prevalent in Europe.

Global Economic Outlook

The global economy remains weak across the board, with no significant signs of improvement since our last baseline. The one positive sign is that some forecasters are beginning to recognize that growth in 2010 is not a foregone conclusion. The OECD, for example, now forecasts contraction of 4.3% in 2009 for the OECD area as a whole – and 0.1% contraction in 2010.  This is broadly with our previous “L-shaped” recovery view.

Even that forecast, however, expects quarter-over-quarter growth rates to be positive beginning in Q1 2010. (This is not a contradiction: if growth is sharply negative in early 2009, then quarterly rates can be positive throughout 2010, without total output for 2010 reaching average 2009 levels.) While most forecasters expect positive growth in most parts of the world in 2010, those forecasts seem to reflect expected reversion to the mean rather than any identified mechanism for economic recovery. The underlying assumption is that at some point economic weakness becomes its own cure, as falling prices finally prompt consumers to consume and businesses to invest. But given the unprecedented nature of the current situation, it seems by no means certain that that assumption will hold. In particular, with demand low around the globe, the typical mechanism by which an isolated country in recession can recover – exports – cannot work for everyone.

Continue reading “Baseline Scenario, April 7, 2009”

Baseline Scenario, 12/15/08

Baseline Scenario for 12/15/2008: pdf version

Peter Boone, Simon Johnson, and James Kwak, copyright of the authors


1) The world is heading into a severe slump, with declining output in the near term and no clear turnaround in sight.

2) Consumers in the US and the nonfinancial corporate sector everywhere are trying to “rebuild their balance sheets,” which means they want to save more.

3) Governments have only a limited ability to offset this increase in desired private sector savings through dissaving (i.e., increased budget deficits that result from fiscal stimulus). Even the most prudent governments in industrialized countries did not run sufficiently countercyclical fiscal policy in the boom time and now face balance sheet constraints.

4) Compounding these problems is a serious test of the eurozone: financial market pressure on Greece, Ireland and Italy is mounting; Portugal and Spain are also likely to be affected. This will lead to another round of bailouts in Europe, this time for weaker sovereigns in the eurozone. As a result, fiscal policy will be even less countercyclical, i.e., governments will feel the need to attempt precautionary austerity, which amounts to a further increase in savings.

5) At the same time, the situation in emerging markets moves towards near-crisis, in which currency collapse and debt default is averted by fiscal austerity. The current IMF strategy is designed to limit the needed degree of contraction, but the IMF cannot raise enough resources to make a difference in global terms – largely because potential creditors do not believe that large borrowers from an augmented Fund would implement responsible policies.

6) The global situation is analogous to the problem of Japan in the 1990s, in which corporates tried to repair their balance sheets while consumers continued to save as before. The difference, of course, is that the external sector was able to grow and Japan could run a current account surplus; this does not work at a global level. Global growth prospects are therefore no better than for Japan in the 1990s.

7) A rapid return to growth requires more expansionary monetary policy, and in all likelihood this needs to be led by the United States. But the Federal Reserve is still some distance from fully recognizing deflation and, by the time it takes that view and can implement appropriate actions, declining wages and prices will be built into expectations, thus making it much harder to stabilize the housing market and restart growth.

8) The push to re-regulate, which is the focus of the G20 intergovernmental process process (with the next summit set for April 2), could lead to a potentially dangerous procyclical set of policies that can exacerbate the downturn and prolong the recovery. There is currently nothing on the G20 agenda that will help slow the global decline and start a recovery.

9) The most likely outcome is not a V-shaped recovery (which is the current official consensus) or a U-shaped recovery (which is closer to the private sector consensus), but rather an L, in which there is a steep fall and then a struggle to recover.

[Details after the jump]: Continue reading “Baseline Scenario, 12/15/08”

Baseline Scenario, 11/10/08

Baseline Scenario, November 10, 2008
By Peter Boone, Simon Johnson, and James Kwak, copyright of the authors

The Baseline Scenario is our periodic overview of the current state of the global economy and our policy proposals. It includes two sections:

  1. Analysis of the current situation and how we got here
  2. Policy proposals

Please note that we do not currently publish our upside and downside risk scenarios in detail.


The roots of the crisis

For at least the last year and a half, as banks took successive writedowns related to deteriorating mortgage-backed securities, the conventional wisdom was that we were facing a crisis of bank solvency triggered by falling housing prices and magnified by leverage. However, falling housing prices and high leverage alone would not necessarily have created the situation we are now in.

Continue reading “Baseline Scenario, 11/10/08”

Baseline Scenario, 10/20/08

Baseline Scenario, October 20, 2008
By Peter Boone, Simon Johnson, and James Kwak, copyright of the authors
Download PDF

The Baseline Scenario is our periodic overview of the current state of the global economy and our policy proposals. It includes three sections:

  1. Updates that have caused us to modify the baseline since the last version
  2. Analysis of the current situation and how we got here
  3. Policy proposals

Please note that we do not currently publish our upside and downside risk scenarios in detail.


This edition of the Baseline Scenario has been extensively updated to reflect recent events, in particular the adoption by the world’s leading economic powers of the first two of our proposals in our original Baseline Scenario.

Continue reading “Baseline Scenario, 10/20/08”

Baseline Scenario, 10/13/08 – Analysis

Baseline Scenario: Analysis, October 13, 2008
By Peter Boone and Simon Johnson, copyright

Published weekly, The Baseline Scenario is divided into two parts: analysis (this post) and policy (a separate post).  In the analysis section, we first explain how we have updated (or not) our views, based on the major developments of last week.  Then, we state our overall view of how the global economy got into its current situation and where this is likely heading. Readers who remember what we said last week can just look at the updates and then go to policy).  The policy section reports our current view on policies in the US and elsewhere.

Please note that we do not currently publish our upside and downside risk scenarios in detail.


Europe recapitalizes

The most important recent development is the – at least partial – shift in European government attitudes during the past few days.  Over the weekend Europe announced a bank recapitalization program, along national lines.  As we prepare to publish, key details remain vague, but it appears they are trying to provide guarantees only at the margin (for new debt, etc).  Presumably this is because the total balance sheets involved are too large for the governments to take on blanket guarantees.

Continue reading “Baseline Scenario, 10/13/08 – Analysis”

Baseline Scenario, 10/13/08 – Policy

Baseline Scenario: Policy, October 13, 2008
By Peter Boone and Simon Johnson, copyright

(For an explanation of the baseline scenario and our analysis, go here.)

The U.S.

The key weapon that the United States possesses is that the U.S. balance sheet is credible.  The U.S. is not going to lose its AAA rating.  The U.S. balance sheet cannot save everyone in the world, but if necessary it can be used to draw a line in the sand and restore confidence.

Today, according to the spreads on credit default swaps – which measure the expected probability of default – investors believe a handful of large and medium-sized banks are safe.  However, these safe names may appear at risk in the future. The government needs to have a plan to protect today’s safe banks from self-fulfilling credit panics if necessary.

Continue reading “Baseline Scenario, 10/13/08 – Policy”

Global Crisis: Latest Analysis and Proposals

Our latest analysis and proposals have been published by the Washington Post (print edition Sunday) in an article by Peter and Simon entitled “The Next World War? It Could Be Financial.” If the world’s leading financial powers cannot agree on a coordinated response, it could be “every nation for itself” – a repeat, on a larger scale, of the emerging markets crisis of 1997-98.  We propose six concrete steps that policy makers – beginning with the G7 and IMF meetings this weekend – can take to limit the risks of such an outcome.

Feel free to comment with criticisms or suggestions.

Decisive, United Action

Events of the past several days have convinced us that the state of the global economy is getting worse and we have revised our analysis and proposals accordingly. In short, coordinated, large-scale actions by the U.S. and Europe, including bank recapitalization plans and guarantees of banks’ obligations, are necessary to limit the spread of a crisis that threatens to trigger national defaults in vulnerable countries around the globe.

Editor’s Note: The content below was originally a separate page, linked to from the short blog post above. I have consolidated it into this single post, after the jump.

Continue reading “Decisive, United Action”

The Baseline Scenario, 2nd Edition

Our weekly baseline scenario is divided into three parts: updates since last week; our analysis of the current situation; and our policy proposals. First-time readers should begin with the analysis and continue with the proposals; returning readers may want to just read the updates and the proposals. (Or download the complete baseline in PDF.)

Despite what seemed at times to be a week filled with news, we think events remain track within our Baseline Scenario from last week.  A big global contraction of credit is underway and a severe recession is in the cards almost everywhere.  Governments continue to respond too slowly and too partially to this.  Europe in particular remains largely in denial (amazing though that may seem after 10 days of bank failures).

Overall, however, our message remains reassuring.  Policy can turn the situation around quickly, if it is applied in a decisive manner (see our policy proposals).  We are optimistic that political leaders will eventually rise to the occasion.

You have probably heard the term, “Living on Internet Time,” which means to experience life at a hectic pace.  I’m afraid we are now living on Financial Market Time, which is like Internet Time, but with teeth.  It would be better if political leaders could step up sooner rather than later.

Editor’s Note: The original version of this document was a separate page with a link from the short blog post above. I have since consolidated the long document into this blog post. It follows after the jump.

Do We Need to Move the Baseline Already?

I thought it might be an eventful day when the news broke that a major bank (Wachovia) was being taken over (by Citi) while I was in the midst of posting our Baseline Scenario.  But I took it in stride, feeling confident that this was consistent with what we thought, broadly, was going to happen — remember that the point of the Baseline Scenario is to make clear, to you and to ourselves, the logic that lies behind what we think will unfold. 

In fact, the details of the Citi-Wachovia deal looked to be very much in line with our expectations (and, yes, we have a list of banks that we expect to run into trouble, but we’re not posting it here.)

The Baseline Scenario can also handle the Paulson Plan struggling in Congress, in two senses.  First, if it doesn’t pass, there are other measures that the Fed and Treasury can take to shore up markets in the short term.  None of these are attractive for the long haul, but we really need to get through November 4, so a new team can get in place (I know they don’t take office until January, and you can’t have more than one President, but there are workarounds.)

Second, even if it does pass, we’re quite skeptical that the Paulson Plan will fix the deeper underlying issues (see the long memo that is the First Edition of our Baseline Scenario).  So you’ve got to get cracking in any case on discussing, educating, and negotiating around a potential Plan B.

Also, market volatility and downward pressure on equity prices are very much in our Baseline.  The dollar, you will have noted, held up rather well today.  Where else are you going to put your money, particularly when there may be further nasty surprises lurking somewhere in the European banking system?

Still, I would mark the day overall as slightly below expectations.  I think it was the general tone and sense that order was lacking (and that expected votes in the House did not materialize).  Also, I wonder what will happen tomorrow, which is not a working day for Congress while the markets will be open.

Days until the election: 35

The Baseline Scenario, First Edition (Our Plan)

This first edition of our Baseline Scenario makes three main points.  First, we are facing a serious crisis of confidence in much of the world’s financial system.  Second, the Paulson Plan may well bring this crisis under control, at least for a while.  But, even so, we should plan ahead for measures to deal directly with the deeper underlying problems of bank capital and restructuring mortages.  Third, if as we expect, further serious measures are needed (particularly bank recapitalization and dealing with the underlying mortgage problems), these are entirely feasible and well within the resources available to the US government.  Governments in Western Europe and some other countries also need to act, and they also have more than sufficient resources at their disposal; however, we remain worried that some of these governments do not yet understand the gravity of the situation.

Update: to be clear, our plan for pulling the global financial system out of its nose dive is at the end of the document; feel free to skip straight to that and then work your way backwards to see our reasoning.

Update: the next edition will appear by 9am Monday morning, October 6.

Editor’s Note: The original version of this document was a separate page with a link from the short blog post above. I have since consolidated the long document into this blog post. It follows after the jump.

Continue reading “The Baseline Scenario, First Edition (Our Plan)”