Economists Agree: Solutions Are Elusive

April 23, 2013

Economists Agree: Solutions Are Elusive


Last week the International Monetary Fund hosted a conference of some of the world’s top macroeconomists to assess how the most intense crisis to have shaken the industrialized economies since the Great Depression has changed the profession’s collective understanding of how the world economy works.

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 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.

Perhaps this is natural. After all, the crisis upended a consensus. Economists and policy makers bred to think that all that was needed to run a prosperous economy was to keep inflation low, strive for fiscal balance and deregulate have found themselves in a more complex world. In this world, financial bubbles matter, capital flows are of dubious merit, low interest rates fail to stimulate growth and government spending becomes the only tool with real traction to spur economic activity.

And there is reason to be cautious. With total government debt in the rich world stuck at around 100 percent of its combined economic output, there is a legitimate fear that a rise in interest rates could tip off a financial death spiral. Moreover, if countries with debt levels well under 50 percent of G.D.P. were so devastated by the crisis, it is hard to imagine what might happen to them if another were to hit them.

Still, the argument against debt is often overstated. Disagreement and uncertainty among economists have given the political systems in Europe and the United States ample license to engage in austerity policies that frankly are proving counterproductive — making recovery more difficult and painful.

In his assessment at the end of the conference, Mr. Akerlof argued that the response in the United States had been reasonable. From the bank bailout to the fiscal stimulus to zero short-term interest rates, “the economic policies postrecovery have been close to what a good, sensible economist doctor would have ordered” for the stranded cat.

But other economists were not quite as sanguine. Indeed, one take-away from the economic conclave is that it may be a fantasy to think that the world’s economies can be steeled to withstand a shock like those the financial system can provide. If so, the urgent task is what kind of limits should be imposed on banking and the rest of finance to temper its propensity to careen toward disaster.

Financial regulation is being tightened around the world. Banks are being required to raise more capital than before. Bigger banks face tougher rules. Still, there is no consensus on which new institutions might be needed to monitor and temper finance, or how tough the rules should be.

What good does the modern financial system do, for the rest of us? What determines financial fluctuations and shocks? How do they affect the broader economy? What can governments do to make them less disruptive? Economists have few answers.

“We don’t have a clue of what financial stability actually means,” Mr. Blanchard confessed.

Mr. Romer said, “Five years into a crisis of this magnitude, we should be, ‘Oh my God, the cat has been in the tree for five years, it’s time to get the cat down out of the tree and figure out how to make sure the cat doesn’t go up the tree again.’”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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