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Editorials

Reforming the Credit Rating Industry. What more needs to be done ? by Marwan Elkhoury, October 2014

Credit rating agencies, (CRAs), were not the cause of the 2007-2008 Global Financial Crisis which began with problems in the US subprime mortgage market and engulfed financial markets globally but their failures to properly assess financial debt instruments have contributed and exacerbated the 2007-2008 financial crisis and highlighted the need for additional reforms.

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News

The Fed's Exit Strategy

(July 15, 2011) The Fed's exit strategy from QE2 explained by Mark Thoma, http://www.youtube.com/watch?v=FqqJXBN14LA&feature=player_embedded;

What's more to be done to rescue an ailing Eurozone union ?

(June 17, 2010)  Richard Baldwin and Daniel Gros from voxeu have just published a new ebook on what's needed to rescue the eurozone from its dire economic predicament.  This new ebook highlights three broken links that precipitated the crisis: (i) the failure of deficit discipline; (ii) the lack of competitiveness policies or counter-cyclical national fiscal policies fostering large current account deficits; (iii) over-leveraged interconnected eurozone banks made fragile by sovereign debt crises feeds into deficits and debt crises which feeds back into bank crises, highlighting the interconnectedness of eurozone banking system and twin crises.  The book makes a number of proposals: (i) as full political union is not on the agenda, reinforce the necessary institutions for better European coordination for national fiscal discipline; (ii) more bank transparency by conducting bank stress tests to be made public; (iii) establish a European Debt Resolution mechanism; (iv) EZ countries to set up national 'Independent Fiscal Councils'; (v) restore competitiveness through labor market reforms; More on the new voxeu ebook here.

An ECB June 2010 FSR Still Downbeat over the overall financial situation for the euro area in 2010 and 2011.

(June 1, 2010)  The June 2010 ECB Financial Stability Review (FSB) highlighted persistent risks to financial stability for 2010 and 2011 in the euro area, mainly, the possibility that concerns about the sustainability of the public finances persist, or even increase, with an associated crowding out of private investment which opened up a number of hazardous contagion channels and adverse feedback loops between financial systems and public finances, in particular in the euro area.  The current FSR indicates that the potential cumulative write-downs on securities and loans for the euro area banking sector for the period 2007 to 2010 is EUR 515 billion.  The expected write-downs on loans will constitute a significant and lasting drag on banking sector profitability and will raise the risk that the recent recovery of profits does not prove durable. At the same time, the pressure on banks to keep leverage under tight control, the disengagement from public support of banks’ balance sheets and the vulnerability of net interest margins of some banks to the prospect of a flattening of the yield curve are likely to contribute to keeping profitability moderate. 

The FSR June 2010 report has identified other risks, albeit less material, outside the euro area financial system, such as the possibility of vulnerabilities being revealed in non-financial corporations’ balance sheets – because of high leverage, low profitability and tight financing conditions – and the possibility of greater-than-expected household sector credit losses, if unemployment rises by more than currently expected.  The report also stressed that in view of the considerable near-term funding needs of euro area governments, a particular concern is the risk of bank bond issuance being crowded out, making it challenging to roll-over a sizeable amount of maturing bonds by the end of 2012. In addition, the vulnerabilities of financial institutions associated with concentrations of lending exposures to commercial property markets and to Central and Eastern European countries remain. There are also risks of heightened financial market volatility, if macroeconomic outcomes fail to live up to expectations.  

Some recommendations have been outlined such as (i) sizeable fiscal imbalances remain and the responsibility rests on governments to frontload and accelerate fiscal consolidation, so as to ensure the sustainability of public finances, not least to avoid the risk of a crowding out of private investment, while establishing conditions conducive to durable economic growth; and (2) for the longer-term, a key objective of the agenda for regulatory reform is to strengthen capital and liquidity buffers so as to ensure a safer financial system that is more robust to adverse disturbances. Swift completion of the process of calibration and implementation of these necessary reforms should remove related uncertainties and allow banks to optimise their capital planning and, where necessary, adjust their business models.  More on the ECB June 2010 FSR here.

Global Defense by ECB and IMF To Shore Up the euro and stop attacks against EU sovereign bond market.

(May 10, 2010)  EU finance ministers set up yesterday night an unprecedented emergency fund worth €750bn (almost $1trillion) and a program of sovereign bond and private securities purchase to stem sovereign debt contagion within Europe triggered by the Greek debt crisis and shore up the euro threatened by a severe confidence crisis.  As the Greek sovereign debt crisis was spreading towards Portugal and Spain and threatening the euro from break-up, the 16 euro members agreed to offer financial assistance up to €750bn to countries under attack from speculators.  Since the onset of the Greek crisis, the EU has been behind the curve, reacting belatedly to events without credibly convincing financial markets of their willingness nor ability to defend the euro.  Berkeley Uni Barry Eichengreen commented saying that the EU has bought itself significant amount of time to do the right thing.  How markets will react to this massive offensive and definitely surprising move is anybody's guess.  Asian markets this morning have reacted positively, pushing up the euro 1.4% in Tokyo to 1.2931.

IMF Raises Growth Forecast for 2010 to 4.2%, Seeing Varying Speed Recovery

(April 22, 2010)  IMF forecast a sustained global growth for 2010 into 2011 was raised to 4.2%, following a .5% contraction in 2009.  In its latest World Economic Outlook, (WEO), the IMF said among the advanced economies, the United States is off to a better start (expected to grow at 3.1%) than Europe (1%) and Japan (1.9%). Among emerging and developing economies, emerging Asia is leading the recovery, with China's expected growth reaching 10%, India, 8.8%, while many emerging European and some CIS economies are lagging behind.  Sub-Saharan Africa has weathered the crisis well and its recovery is expected to be stronger than in previous global downturns with growth levels for 2010 at 4.7%. A key concern is that room for policy maneuvers in many advanced economies has either been exhausted or become much more limited. Moreover,sovereign risks in advanced economies could undermine financial stability gains and extend the crisis. The rapid increase in public debt and deterioration of fiscal balance sheets could be transmitted back to banking systems or across borders.  Combating unemployment is yet another policy challenge in advanced economies.  At the same time, better growth prospects in many emerging economies and low interest rates in major economies have triggered a welcome resur- gence of capital flows to some emerging economies. These capital flows however come with the congruent risk of inflation pressure and asset bubbles which should be tackled through specific macroeconomic policies of exchange rate, interest rate levels and capital control management (See GDB News Note here).  Read the latest IMF WEO report here.

ECB Warns of Global Sovereign Debt Challenges

(April 15, 2010)  Most governments in the advanced countries will exit from the recession with the highest deficit and debt-to-GDP ratios recorded in times of peace, said Jürgen Stark, member of the ECB Executive Board.  The general government deficit in the euro area is expected, according to the latest projections by the European Commission, to exceed 6.0% of GDP in 2009, 2010 and 2011. In Japan, the government deficit-to-GDP ratio is foreseen to reach around 9.0% of GDP in these years, whereas the UK and US government deficits are expected to be in excess of 10.0% of GDP in the period 2009-11. These high government deficits are reflected in mounting government debt, which will reach 88% of GDP in 2011 in both the euro area and the United Kingdom, 100% of GDP in the United States and 200% of GDP in Japan.  In the euro area, adverse fiscal developments are a cause of particular concern in several countries, generally those that did not exploit more buoyant economic times to firmly consolidate their public finances, noted Stark.  

There is no doubt that fiscal policies have been put on a path that is not sustainable. Simulations done by the ECB for the euro area show that, without a very ambitious fiscal adjustment effort, the debt ratio is projected to continue rising in the next decades. With an annual structural deficit reduction of only 0.5% of GDP, it will take the euro area 20 years or more to return to the pre-crisis debt-to-GDP level. Substantially stronger consolidation efforts are warranted to bring the debt ratio down to a more prudent level of below 60% of GDP and to prepare for the rising budgetary costs of the ageing population.

The challenges are particularly large for countries with relatively high government deficit and debt levels, as well as a rapidly ageing society, and even more so for those that face relatively high interest rates and low potential growth.  Outside the euro area, bringing the public debt ratio back to safer regions appears even harder for the United Kingdom, the United States and Japan. Given their high budget deficits and the high and rising debt levels, they must undertake very strong consolidation efforts to manage a reversal of the rising trend in public debt ratios. More on Stark's speech here.

'Third World' concept outdated said World Bank chief Zoellick

(April 15, 2010)  Old concepts of the “Third World” no longer apply in the new multipolar global economy and new approaches are needed to take account for the interests of developing countries, said World Bank Group President Robert B. Zoellick.  Zoellick said that the global economic crisis of 2009 and the rise of developing countries in the global economy was the death-knell of the old concept of the Third World as a separate entity just as 1989 was for the Second World of Communism. This has profound implications for multilateralism, global cooperative action, power relationships, development, and international institutions such as the World Bank Group, and necessitated approaching problems with a new perspective.  While poverty and fragile states remained as challenges to overcome, developing countries were growing to represent an ever increasing share of the global economy and providing an important source of demand for the recovery from the recent global economic crisis. This was not only occurring in China and India, but also in South East Asia, Latin America, and the Middle East,. Africa could also one day become a pole of global growth.  “With power comes responsibility. Developing countries need to recognize that they are now part of the global architecture,” said Zoellick.  The World Bank press release and video can be found here.

IMF Warns Emerging Countries to Stem Sudden and Large Inflows of Capital Through Capital Controls

(April 14, 2010)  In a new, albeit, positive reversal of macroeconomic policy advice, the IMF advised emerging markets to control capital flows to stem sudden and large flows of capital.  As part of their latest Global Financial Stability Report, the IMF warnedthat abundant liquidity brought about by unprecedented liquidity creation in the advanced economies could cause problems to some emerging economies and that macroeconomic policies could be used to manage inflows and outflows of capital.  A surge in capital inflows can cause strong rise in asset prices and inflation in receiving countries.  IMF advises more flexible exchange rate policies or a floating exchange rate, especially when exchange rates are undervalued, as in China, say.  If inflation permits it, a reduction in the interest rate to lessen the attraction for investors who are seeking higher returns.  Tightening fiscal policy if overall macroeconomic policy is too loose.  Liberalize controls on capital outflows to allow domestic agents to invest abroad and, if needed impose temporarily controls on capital inflows to reduce the attractiviness of domestic assets.  IMF analysis here.

The 4 'deadly Ds' of the economic and fiscal consequences of financial crisis

(April 12, 2010)  Carmen Reinhart and Ken Rogoff recently wrote a paper, examining the international aftermath of severe banking crises in the world (see previous GDB News Note here).  Their paper emphasizes the 4 deadly 'Ds' associated with financial crises, namely (i) the sharp economic 'Downturn' following banking crises with cumulative housing price declines of over 35% and asset prices down 55% on average; (ii) Declining revenues and higher expenditures owing to bail-outs and higher transfer payments and higher debt service payments lead to worsening budget 'Deficits', increasing from 0% to 15%; (iii) the deterioration of government finances brings a rise in 'Debt' of over 86% on average; (iv)which inevitably triggers sovereign rating 'Downgrades', if not sometimes 'Default'.  We can see this scenario being played out in front of our eyes in the case of Greece and previously Ireland and Iceland and possibly followed by Portugal, Spain, the U.K. and the U.S.A in the next one or two years from now.  Reinhart and Rogoff's (R&R) paper shows that is what to expect historically after severe financial crisis, and the 2008 financial crisis is no less fearful than the 1929 Great Depression.  For Reinhart analysis here and R&R paper here.

A world in crisis !  A new economic thinking in question !

(April 11, 2010)  Many of the top world's economists and Nobel prizes met in Cambridge, U.K., to discuss the financial crisis, the failure of markets and economic thinking and the need for a new economic thinking at the iNet (Institute for New Economic Thinking), a think-tank initiated and funded by the financier Georges Soros.

The 2008 financial crisis has exposed the two fundamental axioms of economic theory, the Efficient Market Theory (EMT) asserting that market are efficient and self-correct and the Rational Expectation Theory (RET) assuming that all economic agents are fully rational, as flawed and in need of hard re-thinking.  The 2001 Nobel economic winner Georges Akerlof noted that economic agents are not fully rational, they may become over-confident beyond rationality, capitalism may produce 'snake oil' or fake assets and tell itself 'stories', failing to fully understand the risk involved or driven by self-confidence in EMT and moral hazard which creates booms and bust of increasing proportions.

In fact, markets and the world is dominated by 'uncertainties' impossible to fully quantify and information is 'imperfect'.  Soros reitereated some of these points about the flaws in EMT and RET and the positive and negative feedback loops, self-reinforcing and self-defeating, within the cognitive and causal relations in the thinking process, a concept which he called 'reflexivity', which create uncertainties and explain booms and bust, and lately, the meltdown of the financial system.

In fact, the 2008 financial crisis exposed the entire capitalism system with a confluence of failures from economic agents, banks, markets, regulators, governments and economic theory.

Kalesky pointed out, not just the failure of morality, but of ideas and the need to find a relationship between assumptions and reality.  Kalesky emphasized that no one has the right answer that is wholly valid for all and for all times.  Economic thinking has become a monopoly of ideas instead of a maelstrom of competing ideas and paradigms.  One blunt example was the idea of a vertical Phillips curve, an inverse relationship between the rate of unemployment and inflation, that has turned, in the past 15 years, horizontal.

AS the world is in crisis and economic theories discredited, there is a need to re-think the entire economic edifice, an ambitious project set to itself by the Cambridge-based Soros-funded Institute of New Economic Thinking (iNET).  However, as usual, no one seems to agree on the causes nor on the remedies, which makes the conference even more interesting.  More on the iNet here.

Free-Marketeer Alan Greenspan Now Recommends Stringent Rules for Financial Markets.

(April 8, 2010)  Former Fed Governor Alan Greenspan, to this date, a staunch believer and advocate of the 'Efficient Market Theory', in a testimony to the U.S. Financial Crisis Inquiry Commission ydy, highlighted several key issues besetting financial markets: (i) systematic underestimation of risk, especially tail risk; (ii) the virtually undecipherable complexity of a broad spectrum of financial products and markets; and (iii) the failure of the regulatory system.  "Banks have been undercapitalized for the past 40-50 years", Greenspan told the panel.  Greenspan proposed a series of preventive measures such as (i) increasing capital adequacy and tangible equity capital ratios; (ii) introducing contingent capital and automatic rules.  For TBTF (too big to fail) banks, Greenspan suggested breaking up the TBTF banks ... after they fail; Greenspan noted that the complexity of financial markets has become 'awesome', 'toot complex for regulators' and 'far beyond anyone's reaching capacity'.  

The devil is in the details.  What is 'TBTF' ?  How to estimate risk when it is too complex to fathom ?  What about contagion effects and macro correlations ?  Here is Greenspan's testimony and here an overview by James Kwak's Baseline scenario.

Should China renminbi (RMB) be appreciated or not ?

(April 6, 2010)  Chinese current account surplus has become an ever contentious issue with the USA.  Paul Krugman has called upon the US Administration to declare China a 'currency manipulator' which would trigger, if it happens, trade sanctions against China.  This issue even provoked a fierce debate between Krugman on one side and Morgan Stanley's Chief economist for Asia Stephen Roach on the other side, echoing in fact the fierce debate that is taking place between US and Chinese officials.  US Treasury Secretary, Timothy Geithner has been reported asking for a postponment of the April 15th deadline for the annual review report on global foreign-exchange policies.  Bloomberg reports that the Chinese president Hu Jintao was scheduled to visit the US on April 12 for a security summit which would discuss, inter alia, possible sanctions against Iran in a bid to curb its nuclear weapon program.  But the question remains if China should revalue its currency to reduce its current account surplus and global imbalances.  Most economists would agree that China renminbi is probably undervalued although they disagree on the degree of undervaluation.   Some say 40%.  Others 15-18%.  What is less clear is the effect of a RMB reevaluation would have on global imbalances and its current account surplus.  China had already reevaluated its currency in 2005 and moved to a 'soft peg'.  It is too easy to blame China for the US double-digit unemployment and its large trade and current account deficits.  Yiping Huang of Peking university offers other reasons in addition to exchange rate misalignment for the Chinese trade and current account surplus.  Huang proposes domestic structural reforms in labor and capital markets for both countries of which the exchange rate would be but one element in the reform package.  Huang believes that focusing only on the renminbi would be counter-productive and ineffective.  Huang paper can be read here and an overview here.

An EU Agreement for Greece and An EU Economic 'Governance' Profiling On The Horizon

(March 26, 2010)  Last night, the EU Commission agreed on a plan of aid to solve Greece's debt problem which would involve the IMF as a junior partner.  This aid to Greece will come only as a 'last resort' solution if Greece cannot borrow from the markets.  The aid will come at markets rates and not on the basis of subsidized rates, except for the portion brought by the IMF, amounting eventually, to a third of the aid that would be provided.  Any decision by the eurozone countries to lend money would have to be unanimous, based on an assessment made by the ECB and the European Commission.  France and Germany reached this compromise to, hopefully, save Greece and the euro from further speculative attacks.  ECB president Trichet, who, initially, opposed an IMF involvement, expressed satisfaction with the plan.  Two questions remain: (i)  will the markets buy this agreement ? and (ii) will this agreement save Greece from bankruptcy ?  If it works, this plan could serve as the basis for other EU countries in need and form the initial framework for a strengthening of fiscal discipline and sovereign debt default resolution mechanism within the EU.  The next few weeks or months will test the deal.  More on the agreement in Le Monde and the FT.

Debating the creation of a European IMF and how to repay Greece's debt.

(March 22, 2010)  Daniel Gros and Thomas Meyer have recently made the suggestion of a 'European Monetary Fund' in the likes of the IMF, (see GDB News dated Feb. 22, 2010).  Charles Wyplosz, Professor at the Geneva-based Graduate Institute, (IUHEID), finds the idea of a 'European Monetary Fund', 'ludicrous'.  Wyplosz made his comments in the Swiss-based Le Temps newspaper.  Wyplosz adds that it would quickly become a scapegoat.  Legally, the European Treaty does not allow a bail-out of European nations by the European institution.  Contrary to ECB head, Wyplosz believes that the IMF has been strengthened and refinanced at the G-20 summit to be able to lend to debt-stricken nations and makes a living out of refinancing debt-ridden nations. The much-talked about EMF would not have the ability to do so. You can find Wyplosz's analysis here.  Meanwhile, no agreement yet in Europe on how to help Greece repay its debt.  German Chancellor Angela Merkel believes Greece should seek help from the IMF if it needs any help.  The European Commission president Jose Manuel Barroso, instead, together with the French president Sarkozy and the ECB chief Trichet, believe in a European solution and considers going to the IMF a humiliation.  GD Bridge believes that the best solution would be a European solution managed by the IMF.  IMF has the staff to monitor a debt restructuring plan and, theoretically, the means to punish those who stray from the plan by withdrawing funds.  Moreover, it would be much cheaper to borrow from the IMF than from the markets, even with a European guarantee.

Addressing the global fiscal challenges.

(March 22, 2010)  Greece is not the only country facing a fiscal challenge.  Most advanced nations, because of the GFC, are seeing their debt level to GDP rise from 75 percent in 2007, on average, to well over 100 percent by 2014, a time when global fiscal stimulus would have been wound up.  IMF First Deputy-Manager, John Lipsky, warned wealthy nations that although the recovery was on course, the GFC is leaving deep scars in fiscal balances, in particular in advanced economies.  The IMF has projected that gross general government debt in the advanced economies will rise from an average of about 75 percent of GDP at end-2007 to about 110 percent of GDP at end- 2014, even assuming that the temporary, crisis-related stimulus measures are withdrawn in the next few years. Indeed, we expect that all G7 countries except Canada and Germany will have debt-to-GDP ratios close to or exceeding 100 percent by 2014. Already in 2010, the average debt-to-GDP ratio in advanced economies is projected to reach the level prevailing in 1950, in the aftermath of World War II.  Ironically, the fiscal situation among most emerging economies is more favourable where the average debt to GDP would decline next year after rising in 2009 and 2010.  Lipsky's speech at the China Development Forum here.

An EU fiscal sustainability trap

(March 17, 2010)  John Mauldin's InvestorsInsight.com has this interesting analysis by Rob Paranteau of MacroStrategy Edge, about the trap of achieving fiscal sustainability for the EU.  As the domestic private sector and the government sector cannot both deleverage at the same time unless the current account or the trade surplus is in sufficient surplus for a sustainable time, and the whole world cannot all be in surplus, something somewhere has to give in.  Which countries would that be ?  The conundrum comes from the fact that there is an accountability relationship or identity between the domestic private sector balance, the government fiscal sector balance and the current account balance.  Changes in one sector cannot be done in isolation of the other two sectors or variables in the equation.  As an exemple, suppose you are Greece and you wish to reduce your fiscal deficit from 12.5% to 3% as a ratio to GDP by 2012, as per the Growth and Stability Pact (GSP), and assuming Greece current account deficit improves by 2% by 2012, reaching nearly 6%, this would imply a private sector deficit of nearly 3%.  Imagine you are Spain, and assuming reaching the same 3% fiscal deficit Maastricht limits by 2012,  with a 2% improvement of Spain's current account, reaching 2.6%, Spain's private sector should be in balance by 2012.  In fact, this would mean a private sector deleveraging ranging from nearly 5% to GDP for Spain to about 7% for Greece within 2-3 years and 9% for Ireland.   Would that be achievable for the private sector and for the current accounts in a post-world great recession crisis ?  Maybe if the euro falls far enough to allow the EU to export more and improves its trade balance rapidly.  However, as most EU trade is intra-EU and to its close periphery and not to the rest of the world, this would be a difficult act to achieve. The complete article is here.

A new index for financial conditions

(March 12, 2010)  Two private investment analysts (Jan Hatzius of Goldman Sachs and Peter Hooper of Deutsche Bank) teamed up with three academics (Frederic Mishkin of Columbia Uni, Kermit Schoenholtz of NYU, and Mark W. Watson of Princeton Uni) to produce a new Financial Condition Index, (FCI), the USMPF-FCI index (for Monetary Policy Forum).  Why financial conditions matter ?  Financial conditions can be defined as the financial variables that influence economic behaviour and thus, future economic activities.  The new FCI features three key innovations.  First, besides interest rates and asset prices, it includes 44, a broad range, of quantitative and survey-based indicators. Second, their use of unbalanced panel estimation techniques results in a longer time series (back to 1970) than available for other indexes. Third, they control for past GDP growth and inflation and thus focus on the predictive power of financial conditions for future economic activity.

During most of the past two decades for which comparisons are possible, including the last five years, the authors' FCI shows a tighter link with future economic activity than existing indexes, although some of this undoubtedly reflects the fact that they selected the variables partly based on observation of the recent financial crisis. As of the end of 2009, unlike many other FCIs -- Bloomberg, Citi, DB, OECD, Goldman Sachs -- which show neutral or return to positive territory, the USMPF-FCI showed financial conditions at somewhat worse-than-normal levels, forecasting lower than average GDP growth, at around 2 percent for 2010, ± 1% standard deviation. The main reason is that quantitative credit measures (e.g. asset-backed securities issuance) remain very weak, especially once they control for past economic growth. Thus, the USMPF-FCI result is consistent with an ongoing persistent drag from financial conditions on economic growth in 2010.  The original paper can be found here.

An IMF for Europe ?

(Feb. 22, 2010)  Two economists, Daniel Gros from the CEPS (Centre for European Policy Studies) and Thomas Meyer of Deutsche Bank argued in the 'Economist', (Feb. 20, 2010), in the wake of the Greek debt crisis, for a European IMF, which they called the EMF, (European Monetary Fund), to address issues of fiscal and financial discipline as well as having a body that can organise an orderly sovereign default.  The EMF would be run along similar governance lines to the IMF by having a professional staff remote from direct political control to conduct regular and broad economic surveillance of EU member countries.

To finance itself, the EMF would take contributions from member countries of 1% of their 'excess debt', the difference between their actual level of debt and the 60% debt-to-GDP limit put by Maastricht as well as 1% over their 'excess budget deficit' over the 3% Maastricht limit.  Any country could then call on the funds of the EMF up to the amount deposited in the past, provided it undertakes its fiscal adjustment programme as approved by the EMF.  This proposal presents an in-house solution to the current European crisis after the Greek debt crisis.  Here is the article from 'The Economist'.

A little revolution at the IMF ?  Thinking the Unthinkable !  Rethinking Macroeconomic Policies !

(Feb. 12, 2010)  IMF's chief economist and MIT Professor-on-leave Olivier Blanchard, and co-authors Giovanni Dell'Ariccia and Paolo Mauro, in a just-published IMF Note: "Rethinking macroeconomic policy", propose to rethink macroeconomic policies following the 2008 GFC.  Blanchard notes that had target inflation been at 4% instead of 2%, central banks would have had more room for manoeuver before hitting the zero bound.  Blanchard now favors raising inflation targets to, say, 4%, instead of 2%.  Basically, monetary policy should not restrict itself to one target, keep inflation low, and one instrument, the nominal interest rate, but could have several targets, besides from stable inflation and output gap, and use several instruments.  Asset prices should also be monitored as well as the leverage of economic agents.  Regulatory policies are also important as well as widening the fiscal policy space.  For the latter, a country needs, inter alia, to keep its debt to GDP low.  For small open economies, more than an inflation target, an exchange rate could also be a target to stabilize.  All these suggestions are a complete turn-around for the IMF, although many Development economists had been advocating similar views for years, opposing the IMF on its strict low inflation-only policy and liberal free-market ideologies.  Has the IMF turned Keynesian now ?  GDB praises the authors of this paper for at least, not being afraid of raising deep questions and, in the light of the worst recession since the 1929 Great Depression, rethinking what was for IMF, before, unthinkable.  The world is changing, is so also the IMF ?  You can read an interview with Blanchard in WSJ here.

Is this time any different ?

(Feb. 10, 2010)  As the world grapples with the aftermath of the 2008 Great Financial Crisis, (GFC), and Greece struggles to stay afloat, while speculators attack the euro, it is good to get some perspective about how financial crisis enfold, especially when they originate in the center.  That is what a 2008 paper by C. Reinhart and K. Rogoff, (R&R), entitled: "This time is different: A panoramic view of eight centuries of financial crises", offers us, a “panoramic” analysis of the history of financial crises dating from England’s 14th century default to the current United States sub-prime financial crisis. The two authors find that serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies.  In the case of Greece, R&R's paper estimates that Greece has been in default roughly one every two years since it first gained independence in the 19th century.  And loss of credibility, as is the case for Greece, ensues.  Moreover, one of the more striking regularities that R&R found is that after a wave of international banking crises, a wave of sovereign defaults and restructurings often follows within a few years.  After the financial crisis and bank debacle of the two previous years, followed by waves of quasi-sovereign defaults such as Dubai World and now rising sovereign default, the world should be prepared for more of the Greek scenario enfolding in other highly leveraged countries, such as with Portugal, Spain, Ireland, Italy and why not, Japan, the U.K. and the USA.  (R&R's paper here).  GD Bridge believes that the EU which does not have a 'Fiscal Crisis Management Board', or a 'Fiscal Union' treaty, next to its monetary union, will have to quickly find the tools to address such situations within its fold before markets coordinate a frontal attack on weakened EU states, as they have done on Greece.  So, is this time any different ?  Maybe not !  Only history would tell !

Why not Double Liability for Bankers ?

(Jan. 28, 2010)  Why shouldn't bankers pay for their own mistakes instead of taxpayers, in an unfair world where "I win, you lose" dogma prevails.  Axel Leijonhufvud, Professor of Monetary Policy at Trento university and Emeritus Professor at UCLA, suggests a return to a 'double liability' game for bank managers to restore risk ethics among managers and not just 'Heads, I win, Tail, you lose' prevailing dogma among bankers.  So far, most of the reform talks have been largely focusing on capital requirements and macro-prudential regulations, and very little attention has been focused on the structure of liability in banking.  More on this issue on Voxeu here and Sinn, (2008), here.

Is World Poverty Falling ?

(Jan. 28, 2010)  Pinkovsky and Sala-i-Martin, (2010), present new estimates of world income distribution which suggests that world poverty ('less than $1 a day') is falling faster than previously (World Bank) thought.  According to their new study, from 1970 to 2006,  poverty fell most in South Asia, by 86%, followed by South America, 73%, then in the Middle East with 39% and last in Africa with 20%.  The authors conclude that "Barring a catastrophe, there will never be more than a billion people in poverty in the future history of the world".  The World Bank's current estimate stands at 1.4 billion.  One of  the Millenium Development Goal (MDG) goals was to halve poverty between 1990 and 2015.  Moreover, the authors, by estimating world Gini coefficients, a measure of inequality, also reported that inequality had fallen recently, from 67.6% in 1970 to 61.2% in 2006, a slight but significant decrease.  However, one should bear in mind that living on 'less than $1 a day' should be considered as extreme poverty.  It would be useful as well as considering the rest of the income distribution and not just that of the poorest, to see how they fared all these years.  The authors' paper can be found on the NBER website here and a presentation of their paper on Voxeu here.

Obama Hammers on Wall Street Banks

(Jan. 22, 2010)  US President Obama presented yesterday his draft plan to reform the banking system in a bid to reduce the risks of another great recession that taxpayers having to bail out and pay again for the folly of 'too big to fail' banks.  What the proposed reform represents is not clear yet.  Obama's reforms are calling on new rules that could restrict banks size, ban proprietary trading and banks running or even sponsoring hedge funds and private equity funds.  A lot of details remain to be defined.  Will Europe and other countries follow suit ? Reactions have been mixed.  Bank stocks have lost 5% in Wall Street tradings, following Obama's speech.  UK "The Guardian" titled 'UK considers Obama-style banking revolution'. David Prosser from the UK "The Independent" writes that 'banks pay for Obama's reversal in this week Massachussets special Senate seat election.  Swiss "Le Temps" editorial called this 'a step in the right direction'.  Big questions remains in full, inter alia, do these reforms address the real causes behind the financial crisis or not, such as why were banks allowed so much leverages, why did banks hold so much 'toxic assets' ?  Do these planned reforms go far enough to stop big banks to threaten the entire financial system from collapse, bringing down the whole system to its knees ?  Whatever the case, this will be long and protracted discussions in the US Senate and elsewhere in the world before these reforms are clearly defined and put in place.

Financial rules need to be changed if we don't want a repeat of the Great Financial crisis with worse consequences, next time.

(Jan. 19, 2010)  Andrew Haldane, Executive Director, Financial Stability, Bank of England, and Piergiorgio Alessandri, presented a paper, "Banking on the state", last September at the Chicago Fed, 12th annual international banking conference on, what else ?, "The international financial crisis: have the rules of finance changed ?", where they highlight the historical link between bank and the state, although, historically private banks were lending to sovereign for a high price and now it is the reverse with central banks operating as lender-of-last-resort to failing banks which, increasingly, in order to increase their profits, take higher and higher risks, given the implicit state guarantee that if they fail, the state will save them at a greater cost to taxpayers, each time around.  In order to solve this time-inconsistency problem, Haldane et al. suggest various solutions by (i) reducing leverage with higher capital ratios than is currently stated; (ii) recalibrating the risk weights, especially for securitised and re-securitised products; (iii) rethinking capital structure with contingent capital and retail deposit; (iv) reconsidering the whole industrial organisation of banks as well as redesigning the safety deposit net, imposing higher liquidity ratios for banks and self-insurance schemes to lower the probability of central banks having to bail them out.  More details here

Were low interest rates to blame for the GFC ?

(Jan. 13, 2010)  Following Fed's Governor Ben Bernanke's speech at the annual meeting of the American Economic Association, Atlanta, Georgia on Jan. 3, 2010, today's WSJ surveys a number of NBER economists on their views on the relationship between interest rates and the housing bubble.  Most economists interviewed gave a clear 'no' and blamed lax regulations; it's the sub-prime lending, it's wreckless lending, lax regulations, inappropriate business regulations, said some, we get what we ask for, if we ask for no regulations, we get no regulations, said others; the most sanguine blamed the 'Greenspan put' for the crisis, the assurance previous Fed governor Alan Greenspan gave markets that whatever might happen, the Fed had the ability and willingness to clean up the mess which encouraged excessive risk-taking.  You find the WSJ article here and Bernanke's speech here.  Mark Thoma and 2002 Nobel economist laureate Vernon Smith here blame the bubble on too much "cash slopping around", like fuel on fire, that originated from several sources, the Fed being one with too low interest rates, the regulatory failures being another but also global imbalances, being a third, and of course, excessive leverage, allowing the fire to spread more rapidly and getting out of control.  Another Nobel economist laureate, Paul Krugman, basically agrees to Fed Chief Bernanke's arguments in his speech about the links between monetary policy and the housing bubble, as being one element to consider but not its main cause.  However, Krugman squarely blames both Bernanke and Greenspan here for utterly failing to have spotted a housing bubble and seen the dangers when others had spotted it, without properly imagined entirely, we should add, all the potential mess it would bring about to the world economy.  And clearly now what is needed to focus on is how to make the system less fragile.  GD Bridge believes that (a) it is far from clear how to make the system less fragile; and (b) we are far from having done it and (c) we are also far from the end of the tunnel.  The system has been saved from complete wreck and paralysis by huge government bailouts which have extinguished the fire but have not tackled whatsoever the root causes of the systemic problems.  And noone agrees what they are, let alone how to cure the system and last but not least, the total impact and cost of growing budget deficits and sovereign debt for having to bail out banks. 

Krugman believes that "Europe Is OK but the euro isn't"

(Jan. 12, 2010)  Nobel laureate Paul Krugman believes that contrary to what some Americans believe, the European-style of social democracy does not make Europe more stagnant, compared to the free-market US economy.  In productivity terms, Europe is equivalent to the US, if not more productive, given that Europeans work, on average, less than their American counterparts.  Krugman concludes in his blog page that the European experience shows that social justice and progress can go hand in hand.  Read the full story here.

On the question of the euro, Krugman believes that maybe, Europe is not an optimal currency area.  Faced with asymmetric shocks, Europe cannot react adequately as it lacks both a centralised fiscal system and a high labor market mobility.  So, was the euro a mistake, asks Krugman.  There were benefits, he believes, though costs prove much higher than the optimist claimed.  As history cannot be changed, Europe will have to make ways to make it work, Krugman concludes.  You can read Krugman's blog here.

Blinder Not Very Optimistic about Needed Financial Reforms

(Jan. 12, 2010)  The WSJ, (Jan. 11, 2010), ran a commentary by Princeton Professor Alan Blinder entitled: "When Greed Is Not Good".  Blinder's fear is that 'once-in-a-life-time opportunity to build a safer and sturdier financial system is slipping away.  Wall Street has mounted ferocious lobbying campaign against every meaningful aspect of the reform, and their efforts seem to be paying off, comments Blinder.  Adding to this with the salt and pepper of American Senate politics and bickering will probably kill off any remaining substantive regulation.  BIS has recently made a failed attempt to convince investment bankers to tame their greed and their bonuses.  For unashamed bankers, it is business as usual.

Bankers assumed that 'greed was good', making a parallel with Adam Smith's 'Invisible Hand' ideas.  In Smith's vision, according to Blinder, greed is socially beneficial only when properly harnessed and channeled. The necessary conditions include, among other things: appropriate incentives (for risk taking, etc.), effective competition, safeguards against exploitation of what economists call "asymmetric information" (as when a deceitful seller unloads junk on an unsuspecting buyer), regulators to enforce the rules and keep participants honest, and—when relevant—protection of taxpayers against pilferage or malfeasance by others. When these conditions fail to hold, greed is not good.

Blinder comments, that, 'Plainly, they all failed in the financial crisis. Compensation and other types of incentives for risk taking were badly skewed. Corporate boards were asleep at the switch. Opacity reduced effective competition. Financial regulation was shamefully lax. Predators roamed the financial landscape, looting both legally and illegally. And when the Treasury and Federal Reserve rushed in to contain the damage, taxpayers were forced to pay dearly for the mistakes and avarice of others. 'If you want to know why the public is enraged, that, in a nutshell, is why', says Blinder.  Here is the reference to the WSJ article and another reference in the Economist's view here.

Lean against credit cycles not asset prices.

(Dec. 16, 2009)  Following the GFC and even after the 2001 dotcom asset bubble, economists have weighed in whether asset prices should enter into a monetary policy rule, (Genberg, 2001; Cecchetti et al., 2002).  Adam Posen does not think monetary policy should respond to asset price bubbles by adjusting its policy interest rate. He likens this approach to a using a hammer to fix a leaky shower, (read excerpts here).  All of this attention on asset prices is a distraction says William White in a recent paper. Asset bubbles are but a symptom of a deeper problem, an unleashed credit cycle.  "To favor leaning against the credit cycle is not at all the same thing as advocating “targeting” asset prices. Rather, they wish to take action to restrain the whole nexus of imbalances arising from excessively easy credit conditions. The focus should be on the underlying cause rather than one symptom of accumulating problems. Thus, confronted with a combination of rapid increases in monetary and credit aggregates, increases in a wide range of asset prices, and deviations in spending patterns from traditional norms, the suggestion is that policy would tend to be tighter than otherwise", say White in his 2009 paper. More on this issue here.

Has financial innovation led to economic growth ?

(Dec. 10, 2009)  Of all people, Former US Federal Reserve Chairman Paul Volcker, between 1979 and 1987, and now chairman of president Obama's Economic Recovery Advisory board, struck a surprise note to high-level bankers at a conference organised by the Wall Street Journal in Sussex, U.K. on the future of finance, the Future of Finance Initiative, (FFI).  According to the Times Online (09.12.09), Volcker criticised bankers for failing to grasp the magnitude of the financial crisis and belittled their suggested reforms.  Volcker was quoted as saying that: "I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence".  As bankers demanded that new regulation should not stifle innovation, a clearly irritated Mr Volcker said that the biggest innovation in the industry over the past 20 years had been the cash machine, as quoted by the Times article. Volcker went on to attack the rise of complex products such as credit default swaps (CDS).  Meanwhile, the billionaire financier Georges Soros echoed Volcker as he was quoted as saying that CDS should be banned. The billionaire investor likened the widely traded securities to buying life assurance and then giving someone a licence to shoot the insured person.  “They really are a toxic market,” Soros said. “Credit default swaps give you a chance to bear-raid bonds. And bear raids certainly can work.”  More on the FFI conference here.

Credit Booms Can Go Bust !  At What Cost And To Whom ?

(Dec. 10, 2009)  M. Schularik and A. Taylor, (2009), present long-run historical data, 1870-2008, for 12 developed countries, showing that, over the years, episodes of financial crises were often credit booms gone bust.  The authors show that credit growth could be a powerful predictor of financial crises and that maybe ignoring it in a monetary policy rule could be risky.  Schularik and Taylor present new evidence that leverage in the financial sector has increased strongly in the 2nd half of the 20th century, and a decoupling of money and credit aggregates.  The authors also find a decline in safe assets on banks' balance sheets.  The authors also show how monetary policy responses to financial crises have been more aggressive post-1945, but how, despite these policies, output costs of crises have remained large.  One could say that central banks were more successful at bailing out failed financial sector, but failing to protect the real economy, although one would need the counterfactual to prove it. The NBER paper summary can be found here and a paper review in voxeu here.

In the GFC, markets seem to favor policies that formed part of a strategy vs ad-hoc measures.

(Dec. 10, 2009)  Market distress has eased since the height of the crisis, which suggest that some government policies, monetary, financial and/or fiscal policies have been successful, but which ones ?  Voxeu has a paper by Y. Aït-Sahalia, J. Andritzky, A. Jobst, S. Nowak and N. Tamarisa that analyses which policies were succesful in easing market uncertainties.  Aït-Sahalia et al. (2009) paper show that policies that formed part of a strategy versus those that were ad-hoc, were more successful in easing market tensions, reflected by spreads between LIBOR and Overnight Index Swaps (OIS) for the US$.  Announcements of monetary easing, recapitalisation and liability guarantees were associated with the most significant reductions in interbank risk premia. By contrast, ad-hoc measures such as bailouts of individual financial institutions not accompanied by announcements of systematic financial sector restructuring, tended to exacerbate market fears. Moreover, announcements of both policy initiatives and policy inaction had significant international repercussions, which intensified as the crisis developed. More on this paper in voxeu here and IMF paper here.

Bernanke's Cold Shower To Market's Upbeat Mood

(Dec. 8, 2009)  U.S. Fed's Chairman Ben Bernanke dampened market upbeat expectations over last week stronger than expected  U.S. November employment figures by saying that there was "some way to go before the recovery could be self-sustaining".  In a speech on Monday, Dec. 7th, 2009, to the Economic Club of Washington, Bernanke said it remained unclear “whether the recovery will be strong enough to create the large number of jobs that will be needed to materially bring down the unemployment rate”.  Meanwhile, the Fed's chief appeared to signal that he will keep rates at “exceptionally low” levels for an “extended period”.  More on this story in FT, (07.12.09) here.  Global stock markets opened lower after Bernanke's comments.  GD Bridge believes that historically high unemployment figures worldwide, low consumption demand, low bank loans and high mortgage-related risks puts global economies to formidable tests.

Too Much Debt and Too Lax Monetary Policy.

(Dec. 8, 2009)  Daniel Gros, Stefano Micossi, Jacopo Carmassi in (Vox-EU) say that lax monetary policy and excessive leverage are to blame for the crisis.  It argues that many alleged causes of the crisis are symptoms of these policy errors.  If that is correct, then the remedies are remarkably simple.  By and large, there is no need for intrusive regulatory measures constraining non-bank intermediaries and innovative financial instruments.  A repeat of this instability could be avoided in the future by correcting those two policy faults. 

Can low interest rates fuel banks' risk taking ?

(Dec. 8, 2009)  RGE analyses the risk-taking channel of monetary policy: whether low interest rates fuel low-quality lending ?  Low interest rates reduce the relative cost of debt and therefore fuel leverage, including through structured products and financial innovation. Leverage, in turn, is an important ingredient of contagion, through falling collateral valuations and fire sales, once an asset bubble bursts.  (RGE Briefings)  

BIS's Leonardo Gambacorta, (BIS QR, Dec. '09) investigates the link between low interest rates and bank risk-taking. Monetary policy may influence banks’ perceptions of, and attitude towards, risk in at least two ways: (i) through a search for yield process, especially in the case of nominal return targets; and (ii) by means of the impact of interest rates on valuations, incomes and cash flows, which in turn can modify how banks measure risk. Using a comprehensive dataset of listed banks, Gambacorta finds that low interest rates over an extended period cause an increase in banks’ risk-taking. 

Dubai, on the tip of an iceberg !

(Dec. 7, 2009) The forced restructuring of Dubai World's debt is just the latest example of more debt default to come in the next three years or so, the tip of a huge mortgage-related toxic assets iceberg of the order of nearly $ 5 trillion of property debt outstanding in banks in the US and Europe, when debt comes to maturity and needs to be repaid, restructured or face debt default. More on this story in the FT, (07.12.09), here.

OECD claims end of recession albeit 'tepid recovery'

(Nov. 24, 2009)  “The good news is that the recovery – albeit a weak one – is underway", said OECD Secretary-General Angel Gurría, with China leading the global recovery, the US recovering with the help of government stimulus measures, with the Euro area benefitting from the same growth drivers as the US and Japan from strong growth in the rest of Asia. But the OECD SG added that, “With millions of jobs lost and public budgets under strain, governments will have to tread carefully in the months ahead. Removing stimulus measures is imperative but such action has to be carried out gradually to avoid undermining the recovery.” (Read statement here).  In a speech in London, reported by the FT here, IMF Managing-Director, Strauss-Kahn, (DSK), said the global economy stood at the cusp of recovery but remained vulnerable to shocks and policy mis-steps. Fiscal and monetary stimulus programmes should not be stopped too soon, he said.  DSK added: “It is too early for a general exit. We recommend erring on the side of caution, as exiting too early is costlier than exiting too late.” (FT article here)

Econbrowser recession index at 84.6 % ('09:Q2), down from 99.5%('08:Q4)

(Nov. 20, 2009)  Hamilton's Econbrowser recession indicator index is now down to 84.6% (describing 2009:Q2), from a 99.5% peak in 2008:Q4.  James Hamilton (UC San Diego) together with (UC Riverside) Marcelle Chauvet, have, in parallel to the official National Bureau of Economic Research (NBER) late but authoritative announcements for start and ends of recession cycle dates, constructed their own recession index tracking recession cycles, using Bayesian inference probabilities.  Hamilton et al. determined the most recent U.S. recession to have begun in 2007:Q4.  More on the Econbrowser recession index at www.econbrowser.com/archives/rec_ind/description.html.

Uncertainty and the tale of two depressions

(Nov. 18, 2009)  Some time ago (Summer 2009), we reported Eichengreen and O'Rourke piece on the comparison between the 1930 Great Depression and 2008 Great Recession via the synoptic analysis of world industrial production, trade, and stock market, which can be found here. Their main conclusion was that the most recent crisis remained dramatic on 1 September 2009 by the standards of the Great Depression.  Favero of Bocconi University carries the argument further, comparing market volatilities during the 1930's Great Depression and the 2008 Great Recession, using the Aaa-Baa corporate bond spreads and finds a striking difference between the situation now and in the early 1930s. The evolution of uncertainty suggests that the current situation is much less dramatic by the standards of the Great Depression.  You can find the article in voxeu here.

The effectiveness of fiscal and monetary policy in depressions

(Nov. 18, 2009)  The debate over the effectiveness of stimulus rages on.  There is one important source of information on the effectiveness of monetary and fiscal stimulus in an environment of near-zero interest rates, dysfunctional banking systems and heightened risk aversion that has not been fully exploited: the 1930s. Almunia et al. gather data on growth, budgets and central bank policy rates for 27 countries covering the period 1925-39 and show that where fiscal policy was tried, it was effective. Monetary policy in the 1930s was also not powerless, when tried.  More on this in voexeu here.

Commodity prices on the rise again

(Nov. 16, 2009)  Why are commodity prices on the rise again in a world economy that seems to remain weak, asks James Hamilton on his Econbrowser blog.  World commodities have risen, ytd, on average, 37.4 percent.  Hamilton cites 3 explanations: (i) a weak and weakening dollar; (ii) resurging real economic growth outside the US, namely in Asia; and (iii) speculation, increasingly using commodities as an investment instrument and a hedge against US inflation.  More on this at www.econbrowser.com/archives/2009/11/commodity_infla.html.  GD Bridge believes the real and simple explanation is that commodities are increasingly used for carry trades when the real interest rate in the US is not zero but negative !  It makes borrowing in US$ very enticing, especially when the Fed is promising zero interest rates for still quite some time, at least until 2010, even if the US economy picks up again, maybe a new bubble in the making by lax monetary policy in the US and elsewhere.   Liu Mingkang, China’s chief banking regulator, quoted by the FT here, said that the combination of a weak dollar and low interest rates had encouraged a “huge carry trade” that was having a “massive impact on global asset prices”.  But the artificially-kept low Chinese currency may also be fuelling another real-estate bubble in its own turf (more on this in the previous news item).  More on the dangers of the dollar carry trades here.

The illusion of improving global imbalances

(Nov. 16, 2009)  Global imbalances are shrinking at a fabulous rate. Baldwin and Taglioni argue that these improvements are mostly illusory – the transitory side-effect of the greatest trade collapse the world has ever seen. A global recovery will almost surely return the US, Germany, China and others to their old paths.  More on this at http://www.voxeu.org/index.php?q=node/4209.  A stronger Chinese renminbi, as well as other Asian currencies, is needed for global imbalances to ease and increase Chinese domestic consumption, says IMF managing-director Strauss-Kahn, although GD Bridge believes that more than a renminbi appreciation would be needed to boost domestic consumption.  With its large trade surplus and many investors desire to purchase Chinese assets, the renminbi would automatically appreciate if the Chinese authorities let the national currency float as most of the world's major currencies do.  See also Krugman's NYT op-ed piece at www.nytimes.com/2009/11/16/opinion/16krugman.html.  The artificially-kept low Chinese currency may also fuel a new bubble in the Chinese real estate market when investors cream the excess US money supply, by borrowing in US$ at zero interest rate, not to invest it in the real production, but instead, invest it in the Chinese real estate market, kept low due to the low Chinese currency policy rate, or in other emerging markets or in stocks or whatever that provides, supposedly, safe and higher return. 

Confessions of a retiring Swiss National Bank's governor

(Nov. 12, 2009)  Retiring Swiss National Bank (SNB) Governor Jean-Pierre Roth said in an interview to the Swiss French daily 'Le Temps' that Switzerland had no "positive incentives to join the euro zone".  What would Switzerland gain, in Roth's view, if it joined the euro zone, would be a higher interest rate, thus, a higher mortgage rate, and a higher inflation rate, higher by 1 point, on average, than the present one.  More on this at http://www.letemps.ch/Page/Uuid/104f2316-cf12-11de-84d0-2b6eb35c5cae/Jean-Pierre_Roth_confessions

An unbalanced world may again worsen its imbalances

(Oct. 8, 2009).  Morgan Stanley Asia's chairman Roach wrote in the FT (Oct. 7, 2009) that the macro imbalances -- both within and across -- as well as financial regulatory practices and policies, that brought the world to its worst economic crisis since the 1930 Great Depression, may again hit us hard if we fail to adjust them.  Roach cites the US consumption-driven growth economy with the share of consumption to the real GDP remains at 71 percent and the Chinese investment-driven growth with the fixed investment share to GDP has surged beyond the 45 percent in mid-2009. More on Roach's analysis at http: http://www.ft.com/cms/s/0/9cd2e03e-b2d9-11de-b7d2-00144feab49a.html.  

The myth of 'decoupling'

(Aug. 10, 2009). Less synchronised business cycles would be good news for the world economy, allowing for more stable global growth and opportunities for risk-sharing across countries. Is decoupling fact or fiction? Andrew Rose notes that the world’s countries seem to be moving more closely over time, not less. That is, there is little evidence of “decoupling,” the idea that business cycles are becoming more independent and less synchronised across countries.  Wälti (2009) also seems to favor this thesis.  More on this issue here http://www.voxeu.org/index.php?q=node/3829 and here http://www.voxeu.org/index.php?q=node/3814

Could an Early Warning System have predicted this crisis ?

(Aug. 6, 2009).  Andrew Rose and Mark Spiegel believe that few of the characteristics suggested as potential causes of the crisis actually help predict the intensity and severity of this crisis across countries. That bodes poorly for the performance of future early warning models.  More on this story and Early Warning models on voxeu at http://www.voxeu.org/index.php?q=node/3834

Roubini's RGE looks at which countries best weathered the global recession

(Aug. 5, 2009).  Roubini's RGE Monitor found that all economies were affected by the crisis but some more than others.  A combination of policy responses and strong fundamentals have given some countries, especially some emerging countries, a relative edge.  These same strengths could lead those countries to perform better in 2009.  In Latin America, Brazil and Peru.  In Asia Pacific, Australia, China, India, Philippines and Indonesia.  In Europe, Poland, Norway and France.  Canada in North America.  In Middle East and North Africa, Egypt,Qatar and surprisingly, Lebanon.  What have these countries in common ?  RGE cites lower financial vulnerabilities due to more restrictive regulations and less developed financial markets as well as larger and stronger domestic markets that sustained domestic demand.  Moreover, they had the resources to engage in counter-cyclical fiscal and monetary policies.  In contrast, countries that borrowed heavily to finance domestic consumption when money was cheap, are now facing sharp economic contractions.  More on this story on RGE Monitor (though you need a subscription to read it) at http://www.rgemonitor.com

IMF sees light at the end of the recession tunnel by end of 2009 and weak recovery ahead

(July 6, 2009).  IMF predicts that the global economy is beginning to pull out of the global recession thanks to some more energetic emerging economies but stabilisation is uneven and recovery expected to be sluggish.  IMF revised its global growth for 2009 downward since April 2009 from -0.1 to -1.4 but revised its forecast for 2010 upward from 0.6 to 2.5.  More on the IMF update at http://www.imf.org/external/pubs/ft/survey/so/2009/RES070809A.htm;

Inflationary pressures remain low in the EU area

(July 5, 2009).  In its July 2nd monthly meeting, ECB kept its main refinancing rate unchanged at 1%, something that was anticipated by market participants.  ECB expects very low or slightly negative inflation due to ongoing sluggish demand in the euro area.  ECB stressed also that indicators about inflation expectations remained firmly anchored for the medium to longer term.

The new KOF Monetary Policy Communicator for the Euro Area (KOF MPC) provides a quantitative measure of ECB communication. It translates the ECB president’s statements concerning risks to price stability as made during the monthly press conference into an index. By aggregating forward-looking statements concerning price stability, the KOF MPC contains information about the future path of ECB monetary policy. It anticipates changes in the main refinancing rate by two to three months. More about the KOF MPC index at http://www.kof.ethz.ch/publications/indicators/communicator/en

European Commission sees permanent decline in euro area's potential output.

(July 4, 2009).  The European Commission's Quarterly Report on the Euro area says the current financial crisis will cause long-term damage to the euro area and turn its feeble growth prospects into something more sinister, says eurointelligence.  The financial crisis affects both component of productivity - capital accumulation through lower investment rates and total factor productivity.  In the short tun, the effect on potential output growth is a fall of 1.6% in 2007 to 0.7% in 2010.  After the crisis, potential output growth should grow again but below its pre-crisis level that it will not reach again before soon.

GDBridge also believe that similar findings would be found for the US potential output which should reach a post-crisis level that would be lower than the pre-crisis level for quite some time.  more on the European Commission's report at the eurointelligence website at http://www.eurointelligence.com/article.581+M5d03adac278.0.html

Hamilton's Econbrowser Recession Index is currently set at 99.5% (describing '08:Q4)

(July 1, 2009)  James Hamilton of University of California at San Diego, together with UC Riverside Marcelle Chauvet, have, in parallel to the official National Bureau of Economic Research (NBER) late but authoritative announcements for start and ends of recession cycle dates, constructed their own recession index tracking recession cycles, using Bayesian inference probabilities.  For more on that, check Hamilton's Econbrowser site at http://www.econbrowser.com/archives/rec_ind/description.html.  

The current Global Financial Crisis (GFC) is tracking the Great Depression crisis of 1929-1930 or doing worse. 

World industrial production, trade, and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better. Barry Eichengreen of UC, Berkeley and Kevin O'Rourke of Trinity College, Dublin, in a paper soon to be published, show that today's crisis is at least as bad as the Great Depression.  For more on that, check the voxeu webpage at http://www.voxeu.org/index.php?q=node/3421 

Financial crises are protracted affairs.

Carmen Reinhart and Kenneth Rogoff, in a new paper entitled, "The aftermath of Financial crises", (Dec. 2008), find that, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics.  First, asset market collapses are deep and prolonged.  Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.  Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes.  Reinhart and Rogoff show that advanced economies have much in common with developing economies when financial crisis unravel.  Their paper can be downloaded at http://www.economics.harvard.edu/files/faculty/51_Aftermath.pdf

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