Where danger lurks
Olivier Blanchard 03 October 2014
Before the 2008 crisis, the mainstream worldview among US macroeconomists was that economic fluctuations were regular and essentially self-correcting. In this column, IMF chief economist Olivier Blanchard explains how this benign view of fluctuations took hold in the profession, and what lessons have been learned since the crisis. He argues that macroeconomic policy should aim to keep the economy away from ‘dark corners’, where it can malfunction badly.
Until the 2008 global financial crisis, mainstream US macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong and that there is a need for a deep reassessment.
The benign view reflected both factors internal to economics and an external economic environment that for years seemed indeed increasingly benign.
Macroeconomic policy Monetary policy
macroeconomics, global crisis, great moderation, rational expectations, nonlinearities, fluctuations, business cycle, monetary policy, inflation, bank runs, deposit insurance, sudden stops, capital flows, liquidity, maturity mismatch, zero lower bound, liquidity trap, capital requirements, credit constraints, precautionary savings, housing boom, Credit crunch, unconventional monetary policy, fiscal policy, sovereign default, diabolical loop, deflation, debt deflation, financial regulation, regulatory arbitrage, DSGE models
Shadow banking and the economy
Alan Moreira, Alexi Savov 16 September 2014
The prevailing view of shadow banking is that it is all about regulatory arbitrage – evading capital requirements and exploiting ‘too big to fail’. This column focuses instead on the tradeoff between economic growth and financial stability. Shadow banking transforms risky, illiquid assets into securities that are – in good times, at least – treated like money. This alleviates the shortage of safe assets, thereby stimulating growth. However, this process builds up fragility, and can exacerbate the depth of the bust when the liquidity of shadow banking securities evaporates.
Shadow banking, what is it good for? At the epicentre of the global financial crisis, shadow banking has become the focus of intense regulatory scrutiny. All reform proposals implicitly take a stance on its economic value.
According to the prevailing regulatory arbitrage and neglected risks views, it doesn’t have any – shadow banking is about evading capital requirements, exploiting ‘too big to fail’, and marketing risky securities as safe to unwitting investors. The right response is to bring shadow banking into the regulatory and supervisory regime that covers insured banks.
Financial markets Global crisis Macroeconomic policy
shadow banking, banking, financial crisis, global crisis, regulatory arbitrage, liquidity transformation, financial stability, externalities, collateral, business cycle, financial regulation, financial fragility, liquidity, liquidity crunch
The social impact of fiscal policy responses to crises
Carlos A. Vegh , Guillermo Vuletin 12 June 2014
The question of whether fiscal policy should be pro- or countercyclical has become increasingly relevant during the recession. This column provides causal evidence from South American countries showing the success of countercyclical policy in improving social indicators of economic success, combined with correlative evidence from Europe. This represents a strike against the case for austerity-led growth.
Fiscal policy in many developing countries is typically procyclical. Expansionary in good times and contractionary in bad times, these policies often amplify business cycles. The most convincing explanations for such practices seem to be limited access to international credit markets during bad times and political pressures that tend to encourage too much public spending during boom periods (Calderon and Schmidt-Hebbel 2008). Whatever the reason, the pattern is well documented (see Frankel, Vegh, and Vuletin 2011 on the spending side and Vegh and Vuletin 2013a on the tax side).
fiscal policy, business cycle, austerity, cyclicality, LAC-7
How important are sectoral shocks to the macroeconomy?
Enghin Atalay 13 December 2013
Macroeconomic volatility is the weighted sum of sectoral volatility. Business cycle co-movement of sectors must therefore stem from a mixture of common shocks and input-output linkages. My job market paper presents an empirical framework that re-estimates the importance of these two sources. Exploiting previously unused data on industries’ price and input usage patterns, I find that events at individual industries are important – accounting for roughly three-fifths of aggregate business cycle variation.
Most analyses of business cycles, particularly since Kydland and Prescott (1982), rely on economy-wide shocks to preferences and technologies to engender business cycle fluctuations in aggregate economic activity. Whether these economy-wide shocks have origins at a more micro level – at individual firms or industries – is a key unresolved issue in macroeconomics.
Quantifying two sources of co-movement
business cycle, sectoral shocks
Banking crises and political survival over the long run – why Great Expectations matter
Jeffrey Chwieroth, Andrew Walter 10 May 2013
The economic consequences of financial crises have been systematically explored. Their political consequences haven’t. This column argues that without paying attention to politics, crises will remain poorly understood. After all, politics shapes policy choices, market sentiment and, ultimately, economic outcomes. Evidence from the effects of banking crises over the past century show that crises have a dramatic impact on the survival prospects of governments.
The wave of banking and sovereign-debt crises that began in 2007 has had powerful and continuing economic consequences (IMF 2013a; 2013b). Economists have used long run historical data to investigate the economic aftermaths of financial crises, but we lack any equivalent panoramic analysis of the impact of crises on politics. This is an important gap because these political effects, especially the survival prospects of incumbent governments, can shape governments’ post-Crisis policy choices, market sentiment, and thus economic outcomes.
Global crisis Politics and economics
elections, business cycle, Eurozone crisis, Finance
The role of firms in aggregate fluctuations
Julian di Giovanni, Andrei Levchenko, Isabelle Méjean 16 November 2012
What difference does the release of the iPhone 5 really make to the US economy? This column argues that idiosyncratic shocks to individual firms significantly contribute to aggregate fluctuations. Using empirical evidence from France, this column argues that shocks to the largest firms, combined with firm-to-firm linkages, can travel far beyond the sector and country of origin.
Practical discussions of macroeconomic fluctuations are often couched in terms of the impact of individual firms on aggregate GDP. For instance, according to JPMorgan, sales of Apple’s iPhone 5 could add as much as half a percentage point to US 4th quarter GDP growth this year (CNBC 2012). In France, the recent poor performance of Renault and Peugeot is expected to induce a domino effect across the production chain.
Productivity and Innovation
shocks, business cycle, aggregate fluctuations, linkages
Germany should follow in the footsteps of China
Kamil Yilmaz 19 May 2012
Germany’s fiscal response to the crisis was timid compared with those of China and the US. This column uses business-cycle connectedness indices to show that Germany should follow in the footsteps of China and increase its domestic spending so that it will generate net positive connectedness to others. Germany was able to increase its exports thanks to the fact that countries like the US, China and Japan stimulated domestic spending significantly.
After the bankruptcy of Lehman Brothers in September 2008, leading governments around the world announced fiscal packages to provide stimulus to their respected economies. The Chinese government was one of the first. As early as November 2008, it announced a stimulus package that was planned to go into effect immediately in early 2009. The Chinese government also stood out in terms of the size of the package. Its stimulus package contained an additional fiscal spending of $586 billion over a two-year period (each year’s spending was equivalent to 6.9% of 2008 GDP).
Global economy Macroeconomic policy
Germany, China, fiscal policy, business cycle
Have the US and European economies parted company? The signals are increasingly clear
Lucrezia Reichlin, Domenico Giannone, Jasper McMahon, Saverio Simonelli 02 May 2012
According to official statistics, the UK and Europe are heading for recession, while the US is recovering. This has led some to suggest that European economies are moving in the opposite direction to the US. This column, written by the co-founders of Now-Casting, presents new now-casting estimates that put Europe and the US even further apart.
According to the NBER (2012), the last recession ended in June of 2009. CEPR (2012) dates the end of the recession in the Eurozone in the same quarter. For the UK, there is no established chronology but a visual inspection of Figure 1 shows that the recession and the subsequent recovery in the three economies have been highly synchronised.
US, Europe, recession, UK, business cycle, recovery
Protectionism isn’t countercyclical (anymore)
Andrew K Rose 27 April 2012
Conventional wisdom says that when the economy starts to nosedive, the trade barriers start to rise. But this column argues that maybe protectionism isn’t countercyclical after all.
Almost everyone agrees that protectionism is countercyclical; tariffs, quotas, and the like grow during recessions. The abstract of Bagwell and Staiger (2003) begins “Empirical studies have repeatedly documented the countercyclical nature of trade barriers”; for support, they provide citations of eight papers which “all conclude that the average level of protection tends to rise in recessions and fall in booms.” Meanwhile, Costinot (2009) states: “One very robust finding of the empirical literature on trade protection is the positive impact of unemployment on the level of trade barriers.
business cycle, protectionism
What have I done to deserve this? Global winds and Latin American growth
Eduardo Levy Yeyati, Luciano Cohan 12 January 2012
Four years ago, there was growing support for the idea of ‘decoupling’ – that emerging markets were becoming less affected by business cycle swings in developed economies. Then came the global crisis. Focusing on Latin America, this column argues that the 2010s will be a far harder decade. But that might not be such a bad thing if it forces these economies to look again at their growth strategies.
Four years ago, when what would become the worst crisis in 80 years was just a concern for the important but encapsulated US mortgage market, academics and practitioners were debating whether the emerging world, which showed no signs of weakening as the developed world sunk into recession, had entered a new age of real (business cycle) ‘decoupling’.
globalisation, Latin America, decoupling, business cycle, global crisis