nicola viegithe economics of the crisis 1/18 nicola viegi university of cape town and ersa tips may...
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1/18Nicola Viegi The Economics of the Crisis
Nicola ViegiUniversity of Cape Town and ERSA
TIPS May 2009
The Economics of Global CrisesThe Economics of Global Crises
Tips
2/18Nicola Viegi The Economics of the Crisis
The Financial Origin of The Crisis
The Economics of The Crisis
On Prudence
Outline
3/18Nicola Viegi The Economics of the Crisis
The financial origin of the crisis
• Leverage + Financial innovation + Easy Money =
• Financial Crisis
– Originate and distribute banking model
– Increased leverage/maturity mismatch (on/off balance sheet)
– Lax lending standards
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Macroeconomic Consequences
• Credit Crunch
• Collapse in Demand
• Collapse in production and employment
• Collapse of international trade
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World industrial production
60
65
70
75
80
85
90
95
100
5 10 15 20 25 30 35 40 45 50
June 1929=100 April 2008=100
5
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World stock market index (GFD)
30
40
50
60
70
80
90
100
110
5 10 15 20 25 30 35 40 45 50
June 1929=100 April 2008=100
6
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World trade
60
70
80
90
100
110
5 10 15 20 25 30 35 40 45 50
August 1929=100 April 2008=100
7
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Capital Flows
8
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Policy Response Expansionary Monetary and Fiscal Policy everywhere
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Different Policy Response Expansionary Monetary and Fiscal Policy everywhere
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Will it Work? Signs of Recovery
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Will it Work? Signs of Recovery
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Will it Work? It will take time
• Slow Response of the Economy
– Banking Sector is not working (no supply of credit)
– Private sector is not working (no demand of credit – no investment or consumption)
• Explanation?
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Flow-Stock deflation spirals
• Keynesian Saving Paradox
• Fisher’s Debt Deflation
• Cost Cutting Deflation
• Bank Credit Deflation
• Coordination Failures
• What else can go wrong? Protectionism
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Solutions? Public Policy
• Externality is solved by public intervention
– Solve stock problems first (clean balance sheet of banking system – nationalise banking)
– Only than monetary and fiscal policy (to solve the flow problem) will be effective
How Does This Affect Our Understanding of Economic Policy?
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On Prudence
• Two Principles of Economics Under Uncertainty
– Act Conservatively, be prudent– Build Up Insurance against unknowns
The Crisis is a direct result of disregarding inter-temporal stability conditions – too
much debt, too easy money.
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An Example: Chile
Very Smooth Response to the Crisis
18/18Nicola Viegi The Economics of the Crisis
An Example: Chile
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An Example: Chile
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An Example: ChileFoundation: Fiscal Surpluses In Good Time
(If the private sector don’t save, the government should)
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Conclusions
Origin of the Crisis – unsustainable private sector debt
Strong policy response but slow exit
Prudent economic policy is an insurance in good time to deal with bad ones
Private sector and public sector stability rules not different – do not live beyond your means