Category: Classroom

Financial Crisis Macroeconomics for Beginners

(For a complete list of Beginners posts, see Financial Crisis for Beginners.)

If you want to get caught up on the financial and economic crisis in a hurry (and get a quick refresher on first-year macroeconomics), Charles Jones has a drafted a new chapter on the crisis for his macroeconomics textbook. (If you’ve already read all of our Beginners posts, though, hopefully you won’t need to get caught up.) It’s 43 pages long (not very many words per page, though) and includes a relatively standard account of how the crisis came about (with a focus on the U.S. housing bubble), the impact on the real economy, and the thinking behind monetary policy, the fiscal stimulus, and the main proposals to fix the banking system. (Perhaps wisely, he doesn’t say which proposal – buying toxic assets, recapitalization, or reorganization – he recommends.) There is a discussion of what the crisis looks like in IS-LM terms – the main change from the standard version being the jump in the risk premium, which undermines the Fed’s ability to reduce effective interest rates. He also discusses the “zero bound” on nominal interest rates, in case you were wondering what that meant.

I think there should be a lot more on the crisis outside the U.S., for two reasons: first, it’s hitting harder in most other countries; and second, with so many countries being affected in so many different ways (Eastern Europe bubbles collapsing, China and Japan losing demand for exports, Russia hit by falling commodity prices, Iceland crashing under a hypertrophied banking sector), there would be lots to write about.

Jones even closes with a note of optimism:

Whatever happens in the coming years, it is worth remembering a key fact about the Great Depression, in evidence on the cover of the macroeconomics textbook . . . Even something as earth-shaking as the Great Depression essentially left the long-run GDP of the United States largely unaffected.

Update: I meant, but forgot, to add that Jones does not attempt to address the question of whether macroeconomics as a field needs to be revised in the light of the crisis. Mark Thoma has several posts on this question: a few are here, here, and here.

Is This A Crisis Or Just A Recession?

The world seems quiet.  Sure, we have record job losses in the US, a likely decline in global trade for 2009, and what seems like to be a Great Leap Downwards for Chinese growth.  But no one is quite as worried as they were a month ago, let alone two months ago.  It feels, perhaps, like a “regular” global recession (albeit not something we have seen in 20+ years), in which growth decelerates markedly, but then we start to rebound in a timely manner.

Now, I’m happy to accept that as part of my current baseline view (and we will revise our forecast accordingly).  But there are serious downside risks to this forecast, i.e., we could move again into crisis mode.  The three places I look at on a daily basis for crisis-promoting potential are: Continue reading “Is This A Crisis Or Just A Recession?”

Next MIT Class on Global Crisis: Tuesday, December 2nd

Tomorrow, Tuesday December 2, at 4:30pm (please note special start time for this week), we will webcast our next MIT class on the global crisis.  The session will run until 7pm, as usual, with a break around 5:30pm.

This is the last class on the crisis that we will broadcast & record, at least for now.  (There will also be a class on Tuesday, December 9, which will review the crisis to date; I’ll post summary materials but that session will not be recorded.)

On December 2nd, I plan for us to cover the following topics:

  1. The Citigroup Bailout, including whether this is or is not good value for the taxpayer (search this website for Citigroup to see readings).  Robert Rubin’s interview with the Wall Street Journal on Saturday is also essential reading (the WSJ article requires a subscription; the blog naked capitalism provides a free summary and some reactions worth discussing.
  2. The situation in Europe, which continues to worsen.  We’ll review the latest developments in the real economy and indications of various kinds of pressures (think: Italy, but the UK, Spain and other countries may well come up).
  3. Prospects for global financial system reform.  We can see fairly clearly the strategy of President-Elect Obama’s team with regard to fiscal policy, and we can infer some implications for monetary policy.  But what is their likely global strategy, with or without the IMF?  How does this fit with what the rest of the G7 or emerging markets or any other influential players want?  Can we see a full overhaul of the global system coming soon?  If not, why not?  (Search for Global Reform on this website for readings.)

Feel free to post questions here or email to us, through this website.  We’ll cover as many as possible in the classroom discussion.

Details on the webcast and some potentially useful background follow: Continue reading “Next MIT Class on Global Crisis: Tuesday, December 2nd”

Waiting for the European Central Bank, And Waiting

The European Central Bank is widely expected to cut interest rates, perhaps by 50 basis points (half of a percentage point), this week. They could, of course, follow the lead of the Bank of England or the Swiss National Bank and go for a much larger cut (150 basis points and 100 basis points respectively on their most recent rounds). But they probably won’t and not because the economic outlook in the eurozone looks so different from those other parts of Europe or because the the ECB’s Governing Council knows something we don’t or because their interest rates are already low (actually, at 3.25%, they are definitely on the high side.)

The difference really lies in two factors: extreme views about inflation, and the nature of decision-making within the ECB.  Belief that a resurgence of inflation is always imminent is, of course, Germanic but not limited to Germany.  Within the 15 central banks represented on the ECB’s Governing Council, there will always be at least one or two who see unions as looking for an excuse to push up wages.  We can debate whether or not this view is correct under today’s circumstances, but that is irrelevant – these inflation hawks still appear to strongly hold such beliefs.

Of course, there are inflation hawks among all groups that make monetary policy.  But the consensus-seeking process at the ECB is such that even just a few such people can serve as an effective brake on rapid action.  The existence of such views has plainly not prevented the ECB from taking dramatic action on some fronts (e.g., in terms of liquidity provision the ECB arguably moved farther and faster than the Fed last year), but for core monetary policy issues – i.e., when the price stability “mission” is at stake – a couple of outliers can really slow things down (particularly if one or more are members of the Executive Board.)

if the ECB puts through a fairly standard interest rate cut, then it is Business As Usual in the eurozone.  Combined with the rather anemic (or largely smoke and mirrrors) fiscal stimulus in the EU, on top of Europe’s well-known labor market inflexibility (i.e., it is hard to reduce your wage costs, even if business turns down sharply), then the eurozone is in for a rough ride. 

If the ECB surprises the market with a dramatic interest rate cut, at least we will know they are firmly in catch-up mode.  But even then, I’m afraid it is probably too late to have much effect on the recession in 2009.  Under the best of circumstances, interest rate moves affect the real economy with a lag of at least a year.  And the current disruption in the credit market is far from helping monetary policy be effective.

While we will no doubt look back on this crisis as having its epicenter in the U.S., it’s the lack of coherent policy response (monetary, fiscal, regulatory) in Europe over the past year that has really helped turn this into a sustained global crisis.

International Implications of the Citigroup Bailout

The Citigroup bailout was a good deal for Citi shareholders (who wouldn’t appreciate a big transfer from the taxpayer during this holiday season?) and a great deal for Citigroup management.  But it also has three global implications that perhaps have not yet been fully thought through.

1. The Citi deal shifts pressure from US financial institutions, at least for a while.  But to the markets it raises the question: who or what is next?  And the indications again point to the eurozone.  Credit default swap spreads indicate increasing differentiation between Germany on the one hand and, say, Greece (or Ireland or Italy or Spain) on the other hand.  I don’t want to single out Greece, but the recent IMF Article IV Report has some very interesting debt path simulations (the report’s Figure 3) – if you update these in the light of current global circumstances, you can see why Greece may well need a bailout before too long (remember: their government debt is in euros and cannot be inflated away, unlike in the US or UK, for example.)  The market view is that some European governments could not really afford the generous bank bailouts they provided in October.

2. For all the increased discussion among politicians and academics about reforming the global system, to preempt the next crisis, why would the most powerful people on Wall Street want this?  The Citi deal shows that the clout of the US financial industry has, if anything, actually increased over the past eighteen months.  “Wall Street owns the upside and the taxpayer owns the downside” is an old saying which seems more appropriate now – and on a bigger scale – than ever.  There is no harm in proposing changes to deficient national regulatory systems and international, rather creaky, Bretton Woods structures.  But strong forces just found out that these structures are completely compatible with rather juicy bailouts (and there may be more to come), so don’t expect rapid or meaningful real reform. 

3. If we are now at the next stage of bailouts and of figuring out who can afford to do the bailing, then existing resources – in and around the IMF – for helping emerging markets are really not enough.  The G7’s strategy proposal to emerging markets is clearly: “finance, don’t adjust (much),” i.e., keep on growing one way or another.  This might or might not be a good idea, but it will only work if backed by enough official loan support when needed – this is what many countries will need to sustain a current account deficit or offset capital outflows and keep growth on track.  IMF available resources, even with the recent loan from Japan, are only around $200bn.  You really cannot save many banks/countries with that amount of money these days – the IMF lent over $40bn this month alone.

G20 Summit: Just Disappointing or Potentially Dangerous?

Initial reactions to the G20 summit are fairly positive, in the sense that the communique and associated press conferences conveyed (a) there was no open acrimony, (b) the body language was broadly supportive of countercyclical policies, and (c) there may now be a serious international regulatory agenda.

None of this is really new and it could all have been arranged by finance ministers (probably over the telephone), but I agree there is some useful symbolism in having heads of industrialized and emerging market governments convene for the first time (ever?) on these kind of issues.

I will admit to disappointment that no more explicit commitments were made to fiscal stimulus.  I thought the British and the French were heading in this direction, and that they could create some momentum in the right direction.  If Europeans (or anyone else) would like to compete for a “special relationship” with the US after January 20th, they might consider coming to the next summit with substantial fiscal package in hand (as will President Obama). 

If the latest rounds of global economic diplomacy were the Olympics, then China gets gold in the fiscal stimulus category, Germany gets silver, and the UK (so far) is the distant bronze – but the UK does get one more throw next week.  Not the ordering of world economic leadership that one would ordinarily expect, but perhaps that’s a good thing.

In the category of “largest cash contribution designed to save the world from serious disruption”, Japan easily finishes first – their $100bn pledge to the IMF this week was timely, targeted and hopefully not temporary.  Sadly, there were no other entrants in this category.  Perhaps the chemistry and cooking at the White House dinner on Friday will prompt further contributions in the near future?

But there is, unfortunately, another way to read the communique – as a government or international official, for whom this text really is a set of instructions to be implemented.  The whole first part of the document is generic and definitely not new, so – as an official – one’s eye skips through that quickly.  The real issue is the deliverables in the plan of action, with a pressing deadline at the end of March (this is pretty much like saying “do it tomorrow” to an official).  This is where we – an official reader is thinking – must concentrate our immediate attention and efforts.  And most of these specific actions are about tightening regulation on and around credit, or beginning processes that definitely point towards many dimensions for this kind of tightening – accounting standards, hedge funds, risk disclosures, financial sector assessments, credit rating agencies, risk management and stress testing models, international standard setters, sanctions for misconduct, reporting to supervisors in different countries, and more.

There is, of course, nothing wrong with making regulation more effective.  This is surely needed – in both the US and Europe, and probably elsewhere – to help lower the odds of another global financial crisis developing in the future.

But we are still not out of this crisis.  And tightening regulations quickly in the midst of a worldwide credit crunch is one good way to make sure that credit contracts further and faster.  Lending standards naturally tighten in a crisis; the issue to address going forward is how to prevent standards from loosening too much in the next boom – but this is at least several years down the road.  I’m in favor of starting early, but I do not like precipitate action just because you want to look busy and you could not agree on the more pressing issues, such as fiscal policy, support for the IMF, shoring up the eurozone, and so on.

It is true that one (among many) of the stated principles is: “Mitigating against pro-cyclicality in regulatory policy.”  But that is a general statement that is not mapped into operational requirements – except that the IMF and FSF should work together on this, which is a good way to make sure it doesn’t happen.  What officials have to deliver on, by the end of March, is substantive progress with regards to tougher and tighter regulation of credit.  There is a real danger that this action plan – within such a short time frame – can actually make the global downturn dramatically worse.

China’s Stimulus, the IMF’s Forecast, and France’s G20 Agenda

What exactly is on the table for the G20 heads of government meeting in Washington at the end of this week?  One possibility is some sort of synchronized or joint fiscal policy stimulus in most G20 member countries.  (Yes, I know that the communique from this weekend’s meeting of finance ministers and central bank governors was somewhat on the vague side.)

Continue reading “China’s Stimulus, the IMF’s Forecast, and France’s G20 Agenda”