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Nicola Viegi University of Cape Town and ERSA TIPS May 2009

The Economics of Global Crises. Nicola Viegi University of Cape Town and ERSA TIPS May 2009. Tips. Outline. The Financial Origin of The Crisis The Economics of The Crisis On Prudence. The financial origin of the crisis. Leverage + Financial innovation + Easy Money = Financial Crisis

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Nicola Viegi University of Cape Town and ERSA TIPS May 2009

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  1. The Economics of Global Crises Nicola Viegi University of Cape Town and ERSA TIPS May 2009 Tips

  2. Outline • The Financial Origin of The Crisis • The Economics of The Crisis • On Prudence

  3. 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

  4. Macroeconomic Consequences • Credit Crunch • Collapse in Demand • Collapse in production and employment • Collapse of international trade

  5. World industrial production 5

  6. World stock market index (GFD) 6

  7. World trade 7

  8. Capital Flows 8

  9. Policy Response Expansionary Monetary and Fiscal Policy everywhere 9

  10. Different Policy Response Expansionary Monetary and Fiscal Policy everywhere 10

  11. Will it Work? Signs of Recovery

  12. Will it Work? Signs of Recovery

  13. 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?

  14. 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

  15. 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?

  16. 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.

  17. An Example: Chile Very Smooth Response to the Crisis

  18. An Example: Chile

  19. An Example: Chile

  20. An Example: Chile Foundation: Fiscal Surpluses In Good Time (If the private sector don’t save, the government should)

  21. 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

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