4/12/10

The financial/economic crisis - A policy shift from banking regulations to tackling trade imbalances, public debt and economic recovery

  
Σάββατο, 04 Δεκεμβρίου 2010 21:45
A review of the economic press in 2008/2009 reveals that policy reaction to the crisis was not comprehensive and lacked systemic consideration.
Some analysts blamed Wall Street's greedy bankers with their innovative financial instruments, while others, cited reckless homeowners who contracted loans that they could not afford.
- There is no doubt that the starting point of the bubble was the large increase in subprime loans . Periods of economic prosperity are often accompanied by a housing boom. US policy has tended to focus on home ownership as a means of generating wealth and profligate lending tempted many families  to buy overpriced properties which they could ill afford.
-The role of bankers is well documented. Non traditional or innovative instruments were developed in the US and UK mainly through new financial instruments and the absence of regulatory oversight allowed this unethical lending practice to prosper.
The result was that financial markets moved beyond their original function of facilitating cross-border trade and investment.
- Officials of the US Federal Reserve missed the bubble and consequently failed to read events correctly. They held the conventional wisdom of economists, Wall Street executives and home builders   that house prices would not fall. Easing of monetary policy coupled with inadequate regulation over- stimulated the US economy and led to a large expansion in consumption. Ben Bernacke and his predeccesor Alan Greenspan   of the US Federal Reserve were blamed for their careless monetary policies. Other countries introduced easy monetary policies to stimulate their economies and this resulted in increases in public and private debt. .
Europe's malicious delight at the self-demise of the US capitalism was very brief, since European bankers and policy makers also played a part in the housing and financial bubbles.
Initial US and EU   efforts  centred quite correctly, on reforming   banking regulations and   introducing surveillance mechanisms and stress tests for their banks. In parallel the international banking community cooperated in the Basel III framework and formulated capital safety requirements and other standards to prevent future financial crises .
Although as many felt, the crisis started in the US, it has since spread throughout the world , mostly because of the size of the US economy.. The impact on the real economy has been worldwide with rising unemployment, bankruptcies and higher public debt. The global chain of events have expanded beyond the banking/financial sectors and exposed weaknesses in global economic governance.
Led by the US and the EU ,world leaders are now seeking   global solutions to mitigate the effects of any future crisis. A shift in the global policy debate is taking place from purely banking to economic and trade measures. It is felt that imbalances in global trade and capital flows have a key role in the economic crisis and there is the need to tackle real economy issues resulting from trade imbalances, public debt and currency manipulation.
The problem is that the US does not generate enough savings and the large US trade deficit is  resulting in  global economic imbalances. A parallel weakening of the dollar is taking place because of   low interest rates in the US, a policy intended to prevent economic decline. When the dollar declines China buys large amounts of US Treasury bonds to support their currency.
An important player in the global economy, China has already recovered despite the uncertainties mainly due to the impact of their fiscal stimulus. Several other countries have introduced stimulus packages with various degree of success.
At the G-20 meeting in South Korea last October , world leaders discussed international currency movements and global trade imbalances but failed to come up with common policy measures. However, the general statements issued after the meeting represent a step in the right direction. The US administration feels that to resume growth an appreciation of the Chinese currency is needed while China suggested that some countries, notably the US should save more. Resolution of these two problems is critical in order to ensure a recovery in demand. Financial assistance was given by the EU and IMF notably to Greece and Ireland in order to stabilise markets and help them restructure their debts which is important for their economic recovery.
It is widely believed that the international community, at the multilateral –G20 and bilateral levels should intensify its efforts for a speedy resolution of the trade imbalances, currency manipulation and public debt problems in order to ensure aggregate demand expansion and avoid future crises.
This brief note   outlined the causes of the housing and banking bubbles , it then noted a policy shift away from dealing with bubbles to trade imbalances, currency volatility, public debt and economic recovery.

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