November 19, 2017

Economic Scene: Solutions Remain Elusive After Financial Crisis

Two things struck me about the conclave. The first was hearing George Akerlof, a Nobel-winning economist from Berkeley, take to the lectern to compare the crisis to a cat stuck in a tree, afraid to move.

The second was realizing how, after five years of coping with the consequences of the disaster, there is still so much uncertainty about what policies are needed to prevent another financial shock from tipping the world economy into the abyss again a few years down the road.

“We don’t have a sense of the final destination,” said Olivier Blanchard, chief economist of the monetary fund. “Where we end I really don’t have much of a clue.”

In determining what is a sustainable level of government debt, or whether central banks should focus on anything other than inflation, or what should be done to prevent further bubbles from destabilizing economies, he argued “we are still very much navigating by sight.”

If you are one of the nearly five million American workers who have been unemployed for over six months, or one of the six million Spaniards, three million Italians or 1.3 million Greeks without a job or a clear prospect of finding one, this amounts to a tragedy.

Considering that the large and complicated financial institutions that set off the crisis five years ago have only gotten larger and more complex, the gap in knowledge is downright scary.

It is scarier to consider how politicians have chosen to ignore much of what the profession has learned from the experience.

Berkeley’s David Romer counted six shocks that hit the United States in the last three decades alone. The economy dodged the bullet in two — the Latin American debt crisis of the 1980s and the Russian default in the 1990s, which led to the bailout of a hedge fund, Long-Term Capital Management.

It took a hit in three — the collapse of much of the savings and loan industry in the late 1980s, the 1987 stock market crash and the dot.com implosion. But it got hammered in the last one.

Economists used to think it was obvious how to contain such shocks. No point trying to stop a bubble from inflating, they thought; it would be impossible to identify in the first place. The best a central bank like the Federal Reserve could do is stand ready to cut interest rates after the bubble burst, patch up the financial system and set the economy back on track. In terms of budgets, governments should aim for a prudent level of debt to retain space to borrow and spend when it was needed.

Now, interest rates have been near zero for years, and growth has not been restored to acceptable levels. And few if any of the economists gathered at the International Monetary Fund’s headquarters in Washington would venture a guess about what level of debt would be prudent these days.

On the eve of the financial crisis, Spain’s net debt was just over 25 percent of its economic output. The ratio of net debt to gross domestic product in Ireland hovered around 11 percent. Martin Wolf, chief economic commentator of The Financial Times, said that Britain’s debt ratio was close to a 300-year low, way below its level during the Industrial Revolution.

It wasn’t low enough, apparently. Five years later, Ireland’s bailout of its banks took its net debt to 102 percent of its economic output. Spain’s debt hit 80 percent of G.D.P. And Britain’s reached 86 percent — the highest since the 1960s.

This is of enormous consequence. One lesson from the crisis — first learned in the 1930s and corroborated in several contemporary analyses — is that when interest rates lose their power to stimulate the economy, additional government spending can help generate real growth. Still, the fear of “excessive” debt has led many governments to cut spending even in the face of economic stagnation.

Countries like Ireland and Spain have pretty much lost their ability to raise money in financial markets. They are now struggling to reduce debt with little success: cutting public spending in the midst of severe downturns only makes economic performance worse, adding to the debt burden.

Yet even in Britain or the United States, which can still borrow at near-record-low interest rates, governments have taken to cutting public spending at the expense of growth and jobs.

E-mail: eporter@nytimes.com;

Twitter: @portereduardo

Article source: http://www.nytimes.com/2013/04/24/business/solutions-remain-elusive-after-financial-crisis.html?partner=rss&emc=rss