Dr. Miguel A. Alonso Dr. Miguel A. Alonso Neira Associate Professor Applied Economics I Department University Rey Juan Carlos Dr. Miguel A. Alonso The paper presented by Professor Michael Bailey is a very smart and well written article. It shows three political economic paradigms that could be followed in the near future by President Obama. 1. The New Deal’s/ neokeynesians paradigm (more interventionist). 2. The Clinton’s paradigm (less interventionist)). 3. The behavioral economics paradigm. However, for the sake of completeness, let’s deepn in fourth approach: the Austrian School approach (laissez faire). Dr. Miguel A. Alonso This approach will be very useful to complete the ideas developed in this paper, specially those related to: The origins of the current crisis: Market failure vs bad economic policies, institutions, and intervention. The economic policies adopted by developed countries to counter the effects of the financial and economic crisis. What could be done to overcome the crisis? More shortrun intervention and public spending vs market adjustments. 1 2 3 Dr. Miguel A. Alonso The current crisis has multiple causes. In the United States, the most important were the following: 1 2 Dr. Miguel A. Alonso 3 1. Since 1995, the very lax monetary policy of the FED encouraged the dot.com and the housing bubbles (and subsequent burst). Tasa de crecimiento interanual de la M2 y de la M3 (Estados Unidos) 14 12 10 8 6 4 2 Dot.com NASDAQ Dot.com Crisis NASDAQ dot.com 0 -2 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 M2 M3 1 2 3 Dr. Miguel A. Alonso 1. Since 1995, the very lax monetary policy of the FED encouraged the dot.com and the housing bubbles. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees (Moral Hazard) and this has distorted the process of capital allocation. The behavior of the investment community reflects the incentive structure put in place by the authorities. The problem arises when this behavior becomes systemic. 1 2 Dr. Miguel A. Alonso 3 1. Since 1995, the very lax monetary policy of the FED encouraged the dot.com and the housing bubbles. Effects of the expansionary monetary policy were: a) Excessive risk taking encouraged by artificially low interest rates. (Market failure or excessive monetary intervention?) Desviación de los tipos de interés respecto al tipo implícito en la regla de Taylor: i -i (TR ) 2 1 0 -1 -2 -3 -4 -5 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 US 2006Q1 Euro Area 2007Q1 2008Q1 2009Q1 1 2 Dr. Miguel A. Alonso 3 1. Since 1995, the very lax monetary policy of the FED encouraged the dot.com and the housing bubbles. Effects of the expansionary monetary policy were: a) Excessive risk taking encouraged by artificially low i. b) An increasing CA deficit (the mirror of I-S<0) Estados Unidos 25 20 U.S. requires international funding. (China) 15 10 5 0 -5 -10 1990 1992 1994 1996 1998 2000 2002 2004 2006 Diferencial Investment Gross national savings Current account balance 2008 1 2 Dr. Miguel A. Alonso 3 1. Since 1995, the very lax monetary policy of the FED encouraged the dot.com and the housing bubbles. Effects of the expansionary monetary policy were: a) Excessive risk taking encouraged by artificially low i. b) An increasing CA deficit (the mirror of I-S<0) c) A distorsion in the capital structure of the economy. Misleading interest rates: excess of investment and bad investment process Excess of demand of current goods Bad investement process and overinvestment Extension of the early stages of the production process to the detriment of the latest Value of final consumption 1 2 3 Dr. Miguel A. Alonso The current crisis has multiple causes. In the United States, the most important were the following: 2. Pressures that many bureaucrats and public agencies exerted on banks to lower lending standards on mortgages. Under the revision of the CRA in 1995, GSE Fannie Mae and Freddie Mac were pressured to expand and buy mortgage-backed securities. Under these pressures, in 2007 FM and FdM financed four out of five mortgages in the US. Before the crisis started, the American mortgage market was a paragon of intervention and socialism. 1 2 3 Dr. Miguel A. Alonso The current crisis has multiple causes. In the United States, the most important were the following: 2. Pressures that many bureaucrats and public agencies exerted on banks to lower lending standards on mortgages. Under the revision of the CRA in 1995, GSE Fannie Mae and Freddie Mac were pressured to expand and buy mortgage-backed securities. Under these pressures, in 2007 FM and FdM financed four out of five mortgages in the US. Therefore, it is undeniable that subprime mortgages grew under the consent –or the apathy– of the American authorities. (Market failure or excessive market intervention? What about the Glass-Steagall Act?) 1 2 3 Dr. Miguel A. Alonso 1 2 Dr. Miguel A. Alonso 3 An historical research conducted by C. Reinhart and K. Rogoff shows that financial crises are usually followed by government-debt crises. This process starts as private debt is shifted onto the balance sheet of the government (bailout). Then, the problem is made worse as a result of an increase in unemployment benefits and keynesian policies. Banks 1 2 Dr. Miguel A. Alonso 3 United States 1 2 Dr. Miguel A. Alonso 3 Spain 1 2 3 Dr. Miguel A. Alonso These graphs make us aware of some of the costs of keynesian fiscal stimulus: they clearly displays how a short-run fix turns out to be a long-term problem. 1 2 3 Dr. Miguel A. Alonso In the long-run, several major economies –the US and the UK – could see their fiscal position severely deteriorated. According to the Report on Global Sovereign Credit Risk, the Sovereign Debt of these countries has deteriorated significantly. 1 2 Dr. Miguel A. Alonso 3 The market for credit default swaps (CDS) shows that both the US and the UK “were among the worst performing sovereign CDS” at the end of 2009. Concerns are mounting about the increase of debt/GDP ratios. Higher default risk Highest Higher default risk 1 2 3 Dr. Miguel A. Alonso The weakening of the Western countries’ fiscal position, has provoked a political debate on the urgent need for fiscal consolidation. By tightening fiscal policy too late, developed world governments could make things much worse. Currently, in the US public borrowing is crowding out private investment, making harder the economic recovery. 1 2 3 This will put pressure on the FED to “accommodate” the increasing public borrowing (bond issuing) by printing even more money. So the US dollar would be weaker in the future. Dr. Miguel A. Alonso 1 2 3 Dr. Miguel A. Alonso Reinhart and Rogoff again warn us: history shows that high levels of public debt are accompanied by low growth rates. President Obama’s growth projections are too optimistic, because of a fake recovery based on short-run monetary and fiscal expansions. Most of the the measures initiated in response to the crisis, have at best only delayed unavoidable real corrections. 1 2 3 Dr. Miguel A. Alonso We have seen all this before. In the 1990s, the Japan’s government socialized private losses through a massive transfer of private debt to the national balance sheet. This happened in the wake of the Japanese asset bubble, and led to a decade of slow growth and a lack of restructuring of the economy. 1 2 3 Dr. Miguel A. Alonso We have seen all this before. In the 1990s, the Japan’s government socialized private losses through a massive transfer of private debt to the national balance sheet. This happened in the wake of the Japanese asset bubble, and led to a decade of slow growth and a lack of restructuring of the economy. “With the U.S. government stepping in to keep markets from clearing, today's U.S. economy in many ways resembles the post-bubble Japanese economy of the 1990s. Ultra-loose monetary policy and low demand for credit, combined with high unemployment and consumer deleveraging, could lead to a prolonged slump”. Christopher Wood (Wall Street Journal) 1 2 3 Dr. Miguel A. Alonso The increasing deficits and a growing national debt burden on the one hand, and the lower growth rates on the other, could lead into a vicious cycle, whereby investors become more reluctant to put their money into US treasuries. THERE IS NO SUCH THING AS A KEYNESIAN FREE LUNCH!!! In this context, Obama’s Health Law emerges (not a good moment). R. Higgs: “the reform of the health system in the US will be a disaster, not only from the point of view of this specific sector/industry, but also from the perspective of Government finances.” 1 2 3 Dr. Miguel A. Alonso Source: A Citizen's Guide to the 2009 Financial Report of the U.S. Government 1 2 3 Dr. Miguel A. Alonso Source: A Citizen's Guide to the 2009 Financial Report of the U.S. Government 1 2 3 Dr. Miguel A. Alonso 1 2 3 Dr. Miguel A. Alonso The ABCT makes a distinction between the “primary” and “secondary” depressions. The secondary depression is the turmoil in the financial markets. However, the underlying cause is the distortion of the economy’s capital structure: the primary depression. As long as governments and CB continue to focus on the financial symptoms of the “secondary depression” and continue to ignore the structural aspects of the “primary depression”, they act like the old doctors of the Middle Age. An appropriate policy would be to liberalize the economy at all levels to allow the rapid reallocation of productive factors to profitable sectors. 1 2 3 Dr. Miguel A. Alonso On of the biggest threats facing the American economy, is the massive buildup of paper bank reserves. The banks are still holding on to these reserves. But, when they start lending again, the result could be hyperinflation. Hence, the priority of Obama’s Administration should be to find some means for withdrawing those reserves from the banking system avoiding future problems with the dollar. It would be essential to reduce public spending and taxes, in order to increase the available income of heavily indebted economic agents who need to repay their loans. Finally, we need to encourage the accumulation of real saving, stimulating a process of deleveraging in the economy. Dr. Miguel A. Alonso