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What (not) to do about the financial crisis? Dr Alfred Kleinknecht, Emeritus Professor of Economics (TU Delft) & Senior Fellow of WSI (Hans-Böckler-Stiftung) [email protected] Historical background: After the Great Crisis (1929-1941) ….
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After the Great Crisis (1929-1941) …
The Age of Keynes!
All this was a fruitful breeding ground for an anti-Keynesian counter-revolution from the right:
NAIRU = Non-Accelerating Inflation Rate of Unemployment
Mission of the ECB: fight inflation at any price!
Theory of ‘Natural Unemployment’ → You need a rate of unemployment that ensures sufficient competition for jobs → prevent a wage-price spiral (inflation)
For example: Germany “needs” about 6% “naturally” unemployed
From a NAIRU viewpoint, high unemployment in Southern Europe is not a problem … but part of a solution:
Stronger competition for jobs → less solidarity, weaker trades unions → room for supply-side “structural reforms” → downwardly flexible wages allow for higher employment!
Share in National Income in the US:
Of the richest 10%:
… and of the richest 1%:
Source: Atkinson, Piketty and Saez (2011)
US: Domestic debt as a percentage of GDP (1950-2007)"Household" = Consumer and mortgage debt"Business" = Total non-financial business sector debt"Financial" = Total financial sector debt"Public" = total public sector debt (local and federal)
Source: US Federal Reserve
Rapid rise in housing prices → higher mortgages
Since the introduction of the Euro, devaluation is no more possible!
→ Mediterranean countries build up ever higher import surpluses …
… and these surpluses were/are financed mainly through credit!
Failing financial markets: ‘our’ financial sector gave easily credit, being blind for risks … while the debt burden grew dramatically
They failed asking risk premiums which could have discouraged borrowing … so borrowing went on, at low interest rates, until the bubble exploded
… and Rating Agencies were sleeping: Mediterranean countries had solid A-ratings until short before the crisis!
You could see long ago that this had to end in a credit crisis! (see e.g. early warnings by HeinerFlassbeck!)
Logic of the theory of ‘natural’ unemployment (NAIRU)
Quickly rising unemployment and cuts on social security
Strong competition on scarce jobs: breaking the power of trade unions and the left (“never waste a good crisis!”)
More political room for “Supply-side politics” → Cuts on social security → downwardly flexible wages → more employment!
Food for right-wing populists: “Our tax money is wasted by lazy people in Southern Europe!”
Then split the Eurozone into a Euro-North and a Euro-South with a (Bretton-Woods-type) exchange rate between them.
… or, if that is not feasible: let individual countries exit the Euro (in a well-managed way)
This is still better than the current practice → there is a risk that anti-European populists gain momentum!
Many banks are still “too big to fail” → they have am implicit bail-out guarantee by governments
If you accept more risks, you make higher profits … and hence the implicit bail-out guarantee gives an incentive for ruthless speculation:
Profits are private
Losses are for tax payers
… realize that government budgets cannot be charged by a second round of bank rescues
Regulators should be given the power to force banks rescuing themselves: Selling new shares and bonds + force a bank’s bond and shareholders to buy them
Three major advantages:
Share and bond holders get stronger incentives monitoring their managers
Banks immediately have larger capital reserves
No more perverse incentives (privatizing profits; socializing losses)
Growing divergence of standards of living and unemployment rates between North and South in the Eurozone
Risk: Growing anti-EU populism can damage the European project!
As the crisis goes on:
High unemployment weakens the trade unions and the left-wing political spectrum → room for supply-side “structural reforms” → lots of low-productive, precarious jobs
Depression and austerity weaken the innovation and knowledge potential in Mediterranean countries