Monday, July 7, 2008

Better to let the bubble burst

Recession is not the worst possible outcome

A substantial economics article from the FT. The conclusions will I suspect receive support here - "We might run a greater risk of a recession in the short term. But a recession is not the worst possible outcome. The worst is for this crisis to go on and on, for Minsky’s moment to become an eternity."

Posted by letthemfall @ 11:35 AM (920 views)
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3 thoughts on “Better to let the bubble burst

  • At last.

    “We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role.”

    Well, every single credit-led expansion in history has led to economic catastrophe – that could be a clue.

    “Second, monetary policy should be geared towards price stability first and foremost. When inflation expectations rise, real interest rates should be positive.”

    Bailing out those who have overstretched themselves (including central government) by “losing control of inflation” is not only morally, but economically wrong. It kicks the problem into the long grass but it doesn’t go away.

    “Third, allow some defaulting banks to go bust.”

    Hallelujah. Someone has said it. There’s no way we’re going to see the end of this without that.

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  • this is a superb article. Good to see these views getting an airing.

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  • Agreed, excellent article. The FT truly deserved its Newspaper of the Year award.

    Paul – about allowing some banks to go bust, presumably that’s only acceptable if your life savings aren’t kept in there?

    Wolfgang Münchau’s suggestions for the future:

    “[First,] the priority might be not to impede the fall in asset prices. Real house prices in the US, the UK and several other economies might end up falling by some 40-50 per cent peak-to-trough in the downward phase of this cycle. Let this happen and do not implement policies to prevent this fall – such policies might alleviate some pain in the short run for some people but will make the adjustment last a lot longer.

    Second, monetary policy should be geared towards price stability first and foremost. When inflation expectations rise, real interest rates should be positive. This would necessitate a large interest rate increase in the US and further interest rate increases in the eurozone as well.

    Third, allow some defaulting banks to go bust.

    Fourth, implement long-term policies designed to reduce volatility. Among these are: a change in the monetary policy framework to take explicit account of asset price developments; the removal of pro-cyclical incentives in the banking sector; stricter regulation of mortgages, such as the encouragement of fixed-rate loans and the imposition of maximum loan-to-value ratios; more exchange-rate flexibility in countries with fixed or semi-fixed exchange rates and, of course, the development of alternative energies to reduce our reliance on oil.

    We might run a greater risk of a recession in the short term. But a recession is not the worst possible outcome. The worst is for this crisis to go on and on, for Minsky’s moment to become an eternity.”

    What’s worse than a recession? A Japan-style depression, by the sounds of it.

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