Financial Excesses Research Articles

Whatreallycaused the Great Recession? Rhyme and repetition in a theme from the 1930s

Diagnoses of the 2008 financial crisis have invoked arguments involving real sector developments that, though much debated in the 1930s, had largely disappeared from the literature in recent decades. Prompted by these revivals, the present study re-examines an inter-war conviction that the Depression had its origins in uneven technological progress and monopolistic competition. Effectively reversing the induced roundaboutness view of the Austrian thesis, these writings noted a conflict between the resulting need for monetary accommodation and its potentially destabilising distributional consequences. A common framework permits the extent of similarity in inter-war and contemporary American experience to be assessed, with the comparison drawing attention to the 1990s’ NASDAQ boom and the subsequent financial behaviour of the US corporate sector. Consistently with the earlier literature but contrary to recent conclusions, financial sector excess is seen as an aggravating factor, rather than an initiating cause of the recession.

Sovereigns versus Banks: Credit, Crises, and Consequences

Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper examines the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870: (i) in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.

Sovereigns Versus Banks: Credit, Crises and Consequences

Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper examines the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870: (i) in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.

G20 reforms, hedging and covered bonds

The G20 agreed reforms in relation to over-the-counter (OTC) derivatives in Pittsburgh on 26 September 2009. The Leaders’ Statement1 published after the summit identified ‘an era of irresponsibility’ that required ‘sweeping reforms to reduce the risk that financial excess will again destabilize the global economy’. Going forward, the leaders agreed: To make sure our regulatory system for banks and other financial firms reins in the excesses that led to the crisis. Where reckless behaviour and a lack of responsibility led to crisis, we will not allow a return to banking as usual.2

Security transaction taxes: issues and evidence

In reaction to the financial crisis, increased attention has recently been given to security transaction taxes (STTs) as a means of (1) raising revenue for a variety of possible purposes and/or (2) helping to curb financial market excesses. This paper reviews existing theory and evidence on the efficacy of an STT in fulfilling those tasks, on its potential impact, and on key issues to be faced in designing taxes of this kind.

The role of macroeconomic policies in the global crisis

This paper argues that the lack of timely and decisive policy action to correct domestic and external imbalances contributed crucially to the build-up of financial excesses that led to the financial crisis and the Great Recession. We focus on 2002–2007 and perform a number of counterfactual simulations to investigate two central elements of the story, namely: (a) an over-expansionary US monetary policy and the absence of effective macro-prudential supervision, which permitted a prolonged expansion of debt-financed consumer spending and (b) the choice by China and other emerging countries to pursue an export-led growth strategy supported by pegging their currencies to the US dollar, in conjunction with sluggish domestic demand in major advanced economies characterized by low potential output growth. The results of the simulations lend support to the view that if substantial, globally coordinated demand rebalancing had been undertaken early on, the macroeconomic and financial imbalances would not have accumulated to the extent that they did and the financial turmoil might have had less drastic global consequences.

Not an Exceptional Country: Russia and the Global Financial Crisis of 2008 – 2009

What began as a downturn in the US housing sector in summer 2007 mushroomed into a global financial crisis by September 2008—the most severe since the Great Depression of the 1930s. Initially, Western European governments, including the Russian government, blamed the crisis on US financial excesses and felt that their economies would remain immune from the contagion. However, this proved to be a false comfort. The subprime-induced contagion spread to Europe with unprecedented ferocity, rapidly engulfing the entire continent. This essay explains why Russia, deemed to be the most immune, succumbed so quickly to the contagion, and includes lessons policymakers can learn from the Russian experience to better insulate their economies from the vagaries of the global financial markets.

Macroprudential Supervision and Monetary Policy in the Post-crisis World

Until two years ago, it was believed that the financial system as a whole was self-correcting and that modern tools of stabilization policy—monetary policy in particular—were sufficient to prevent severe economic contractions. We now know that we need a robust system of regulation and supervision that will recognize and prevent financial excesses before they lead to crisis, while at the same time maintaining an environment conducive to financial innovation. This address traces the causes of the crisis and the role of the Dodd-Frank Act in providing a framework for preventing recurrence. It then describes what must be done to identify emerging systemic financial risk, the tools and implementation of macroprudential financial supervision that must be developed, and the role of coordination between monetary policy and macroprudential supervision. Prevention of crises will not be easy—particularly because it will be necessary to walk a tightrope between prevention of catastrophe and keeping too tight a hold on the financial system.

The Role of Macroeconomic Policies in the Global Crisis

This paper argues that the lack of timely and decisive policy action to correct domestic and external imbalances contributed crucially to the build-up of financial excesses that led to the financial crisis and the Great Recession. We focus on 2002-07 and perform a number of counterfactual simulations to investigate two central elements of the story, namely: (a) an over-expansionary US monetary policy and the absence of effective macro-prudential supervision, which permitted a prolonged expansion of debt-financed consumer spending; (b) the decision of China and other emerging countries to pursue an export-led growth strategy supported by pegging their currencies to the US dollar, resulting in a huge build-up of their official reserves, in conjunction with sluggish domestic demand in surplus advanced economies characterized by low potential output growth. The results of the simulations lend support to the view that if substantial, globally coordinated demand rebalancing had been undertaken in a timely manner, the macroeconomic and financial imbalances would not have accumulated to the extent that they did and the financial turmoil might have had less drastic global consequences.

Speculating on Everyday Life: The Cultural Economy of the Quotidian

The economic crisis has generally been understood in terms of financial excess, speculation and fraud. This article suggests that there is a need to decenter this focus on financialization and instead reflect on the crisis as a cultural as much as an economic event. It addresses the normalisation of practices of calculation and investment within everyday life, especially in the figure of the ‘citizen-speculator’ who is now required to view housing as a site of accumulation and object of speculation, not only for debt-fuelled consumption in the present but also as a source of asset-based welfare in the future.

Some lessons for economists from the financial crisis

PurposeThe purpose of this paper is to discuss implications of the global crisis for economic and financial research and policy.Design/methodology/approachThe paper reviews many recent studies on the crisis and offers the author's views on some of the most important lessons to be drawn from the crisisFindingsThe review counters views that the crisis reflected a basic failure of economics, but agrees that it undercuts some particular theories and approaches to economics. More attention needs to be given to imperfections in the operation of both markets and governments, drawing on insights from behavioral and neuro economics and finance and political economy analysis and recognizing the importance of limited information and uncertainty about correct models. The creation of perverse incentive structures explain a large part of the financial excesses that led to the crisis. Financial considerations need to be integrated much more closely with macroeconomic analysis and financial risk analysis needs to pay more attention to economic considerations. Useful insights can be drawn from many different theories and approaches and we should not expect any one theory to have all the answers. The excesses observed in the advanced economies do not imply that there are not enormous benefits to be gained from further financial liberalization in emerging market economies, but they do show that great care must be taken in establishing strong supervision of such liberalizations and highlight many of the dangers to look out for.Originality/valueThe paper offers a guide to the literature for those interested in learning more about the causes and effects of the crisis and policy responses and offers a number of suggestions for fruitful research topics and policy strategies.

In search of a smoking gun: macroeconomic policies and the crisis

This paper looks at macroeconomic factors behind the current crisis. The first part looks at how global macroeconomic trends--including sustained strong growth, low real interest rates, and high saving rates--provided an environment conducive to increased financial risk-taking. The second part examines macroeconomic policies and the international monetary system, assessing whether too easy monetary policy contributed to asset price bubbles, whether excessive reserve accumulation contributed to a glut of global savings, whether the US dollar's reserve currency status aggravated financial excesses, and whether policies in capital-importing countries were sufficiently countercyclical. We do not find a single factor that can explain the crisis and account for differences in countries' experiences leading up to it; instead, the contribution of macroeconomic policy choices seems complex and ambiguous. However, there are still important policy lessons for, in particular, rebalancing economies away from export-dominated growth and having monetary policy place greater weight on macrofinancial stability. Copyright 2009, Oxford University Press.

The current global financial turmoil and Asian developing countries

The world economy is now in difficult straits as a result of the financial turmoil sparked by the subprime crisis in the United States. In this turbulent environment, prospects for sustaining global growth and stability seem to hinge more than ever on developing countries, particularly the emerging-market economies of Asia. This paper contends that the current difficulties are linked to prior financial excesses and regulatory shortcomings which led to a buildup of vulnerabilities in financial and asset markets. The extent to which the Asian countries can decouple their growth from this ongoing turmoil depends on their prevailing domestic economic conditions and their policy response to possible shocks from the crisis. In this respect, fragilities and imbalances exist in many major Asian economies, not least in the form of credit, asset and investment bubbles which were allowed to expand in recent years as foreign capital poured in. Nonetheless, in general, the author maintains, countries in the region do have the policymaking capacity to deal with any adverse trade and financial impacts of the crisis. Beyond the macroeconomic policy response to the present conditions, however, lies an urgent need for regulatory measures which will reduce the systemic instability generated by financial markets and capital flows in the first place.

The NHS: ‘losing my religion’

The NHS: ‘losing my religion’

Extremal analysis of currency crises in Taiwan

We employ extreme value theory to identify currency crises in Taiwan. The new approach is able to identify severe currency crises, and at the same time avoid the crisis-misclassification problem of Markov-switching models. Signal accounting indicates that currency crises in Taiwan are preceded by rapid expansion of domestic credit and other monetary aggregates, implying that financial excesses stressed by the third-generation crisis model are the main causes of these currency crises.

Financial instability and macro-prudential supervision

Financial liberalisation and deregulation have increased financial instability and crises. While the importance of fundamental weaknesses has decreased over time, the impact of the deregulation of the financial and, especially, the banking system has become preponderant. This paper examines the dynamics of the main factors of vulnerability interacting with the financial system and concludes that, in order to prevent financial excesses and systemic malfunction leading to crises, both the preservation of macroeconomic balances and the adoption of a more efficient regulatory/supervisory framework are needed. The latter would be greatly improved by the adoption of a system-wide vision of financial instability and an inter-temporal assessment of the financial risk, in the context of a still-emerging new approach, primarily within the Bank for International Settlements.

Are Changes in Financial Structure Extending Safety Nets?

Significant attention has recently been directed to the optimal policy response when financial excesses threaten. This paper rather addresses issues pertinent to the appropriate policy response once financial difficulties have actually materialised. It begins with some empirical evidence concerning recent changes in financial structure (marketisation, globalisation and consolidation) and documents the rise in the number and variety of episodes of financial instability. The paper then goes on to examine the rationale for government intervention (use of safety net instruments) to reduce the costs of such financial instability, and cautiously concludes that the use of a number of such instruments has been on the rise. Moreover, the balance among them has also been changing. An attempt is then made to link these evolving policy responses back to the underlying changes in financial structure identified earlier. Since the use of safety net instruments always implies in principle some element of moral hazard, the paper concludes with an empirical evaluation of whether this seems to be a matter of practical importance, and whether good design might not have the potential to materially reduce such concerns. The conclusion reached is that sensible policies designed to contain the damage arising from financial instability can have less desirable longer-term consequences. Policymakers thus continue to face an inter-temporal optimisation problem.

Currency crises: Are they all the same?

The plethora of currency crises around the world has fueled many theories on the causes of speculative attacks. The first-generation models focus on fiscal problems while the second-generation models emphasize countercyclical policies and self-fulfilling crises. In the 1990s, models pinpoint to financial excesses. With the crisis of Argentina in 2001, models of sovereign default have become popular again. While the theoretical literature has emphasized variety, the empirical literature has supported the “one size fits all” models. This paper contributes to the empirical literature by assessing whether the crises of the last 30 years are of different varieties.

The telecoms boom and bust 1996-2003 and the role of financial markets

Financial crises are still as much a part of the modern, information-and-communication-technology-based (ICT) economy as they were of previous economies. Why are we apparently unable to learn lessons from the past and avoid what Charles Kindleberger (2000) has called “manias, panics and crashes”? Why is it that our sophisticated stock of information, made readily and relatively cheaply available to us by our investment in ICTs, and our abundant theories and models, have not allowed us to steer clear of these financial excesses? The aim of this paper is to highlight some of the processes and mechanisms that have played a significant role in causing the Telecoms Boom and Bust, 1996-2003. The question of whether anything can be done about these processes and mechanisms in order to try and modify such financial excesses in the future is taken up in the conclusion.

Emerging Market Instability: Do Sovereign Ratings Affect Country Risk and Stock Returns?

Financial market instability has been the focus of attention of both academic and policy circles. Rating agencies have been under particular scrutiny lately as promoters of financial excesses, upgrading countries in good times and downgrading them in bad times. Using a panel of emerging economies, this paper examines whether sovereign ratings affect financial markets. The authors find that changes in sovereign ratings have an impact on country risk and stock returns. They also find that these changes are transmitted across countries, with neighbor-country effects being more significant. Rating upgrades (downgrades) tend to occur following market rallies (downturns). Countries with more vulnerable economies, as measured by low ratings, are more sensitive to changes in U.S. interest rates.