Thursday, March 18, 2010

Dallas Fed The Euro and Dollar in the Crisis and Beyond - March 17, 2010.

I attended a two day euro/dollar event over the last couple of days, with Wednesday's session a general policymaker day on the markets/government policies and the fallout from the financial crisis and the Thursday an academic workshop on European Integration. 

First, on the Wednesday there was a lot of interesting stuff but there were a few points missing from the debate.  See the agenda at http://www.dallasfed.org/institute/events/10euro.cfm

The President of the Federal Reserve Bank of Dallas, Richard Fisher, closed out the day by hitting the nail on the head, in my opinion, with his comments on the recent financial crisis.  He said ( - and here I'm paraphrasing - ) that these events occur with regularity and are just part of human behavior - and we probably will not be able to predict the next adverse event, and have to deal with it when it occurs.

I would go one step further though.  What most people missed at this conference was that this financial crisis was the result of the housing crisis, and has led to a recession, which is just part of the regular business cycle.  In other words although the Great Depression and the current downturn have serious social and political consequences, they are still essentially part of the regular downturns that we have in the macroeconomy known as the business cycle.  The business cycle is just a fact of macroeconomics and until we find a way to stop it occurring with such regularity, we need to just accepted it for what it is - a cycle!!

So why isn't the current downturn different from others as we are constantly being told that this is almost a depression (and has already been called "the great recession" by economic pundits)?  Because it resulted from a bubble in a market ( - the housing market), just like the Great Depression also resulted from a bubble in a market ( - the stockmarket).  What happened in both the Great Depression and the current recession is that both downturns spread to the financial sector, exposing a fault line or two, and causing a financial crisis which then spread to the rest of the economy.  The big difference though is that in the current recession the Fed and the Federal government have done the right thing - they have learned from the mistakes they made at the beginning of the Great Depression and have averted a major disaster.  The thing about most bubbles is that they i) usually don't spread to other sectors in the way they did this time through the financial sector and ii) they usually are not as deep as the current one as they exposed some major weaknesses in the financial services sector.

So shouldn't economists seek to stop what happened recently from happening again?  Most non-economics educated people would say "of course"!  I mean why would a doctor want a cold to reoccur again if they could stop if from happening?  But that's what recessions are - they are basically a mutating virus that hits the economy in different ways each time and can be particularly nasty if the body is physically run down.  But the economy isn't quite like a body - the recession also "cleans out" what economists call "malinvestment" - the bad investments that were done in the previous boom, so that the economy can begin to grow again in a healthier fashion.  Economists who think like this, by the way, are usually labelled "Austrians" after the group of economists who originated in Austria before the second world war. 

So when Adam Posen says "we all made mistakes with the financial services sector", I am not sure I agree.  Noone was going to change the regulatory structure in the US financial services sector without a crisis, so actually this gives the politicians a reason to act.  But the mistakes that were made were made by politicians years ago when they set up the patchwork regulatory framework that allowed "regulatory arbitrage" with also hardly any regulation for financial derivatives.

The big mistake we made, I believe, is not paying enough attention to what happened in Japan in the early 1990s.  Japan is still suffering from the mistakes that were made back then, and luckily we haven't fallen into the same traps as they did...but still it is not a pleasant experience for those people who have lost their jobs, and we are far from being out of the tunnel yet!!

No comments:

Post a Comment

Featured Post

Free Trade on Trial - What are the Lessons for Economists?

This election season in the US there has been an extraordinary and disturbing trend at work: vilifying free trade as a "job kille...

Popular Posts

Search This Blog