1. Nicola ViegiThe Economics of the Crisis 1/18 Nicola Viegi University of Cape Town and ERSA TIPS May 2009 The Economics of Global Crises Tips

2. Nicola ViegiThe Economics of the Crisis 2/18  The Financial Origin of The Crisis  The Economics of The Crisis  On Prudence Outline

3. Nicola ViegiThe Economics of the Crisis 3/18 The financial origin of the crisis Leverage + Financial innovation + Easy Money = Financial Crisis –Originate and distribute banking model –Increased leverage/maturity mismatch (on/off balance sheet) –Lax lending standards

4. Nicola ViegiThe Economics of the Crisis 4/18 Macroeconomic Consequences Credit Crunch Collapse in Demand Collapse in production and employment Collapse of international trade

5. Nicola ViegiThe Economics of the Crisis 5/18 World industrial production 5

6. Nicola ViegiThe Economics of the Crisis 6/18 World stock market index (GFD) 6

7. Nicola ViegiThe Economics of the Crisis 7/18 World trade 7

8. Nicola ViegiThe Economics of the Crisis 8/18 Capital Flows 8

9. Nicola ViegiThe Economics of the Crisis 9/18 Policy Response Expansionary Monetary and Fiscal Policy everywhere 9

10. Nicola ViegiThe Economics of the Crisis 10/18 Different Policy Response Expansionary Monetary and Fiscal Policy everywhere 10

11. Nicola ViegiThe Economics of the Crisis 11/18 Will it Work? Signs of Recovery

12. Nicola ViegiThe Economics of the Crisis 12/18 Will it Work? Signs of Recovery

13. Nicola ViegiThe Economics of the Crisis 13/18 Will it Work? It will take time Slow Response of the Economy –Banking Sector is not working (no supply of credit) –Private sector is not working (no demand of credit – no investment or consumption) Explanation?

14. Nicola ViegiThe Economics of the Crisis 14/18 Flow-Stock deflation spirals Keynesian Saving Paradox Fisher’s Debt Deflation Cost Cutting Deflation Bank Credit Deflation Coordination Failures What else can go wrong? Protectionism

15. Nicola ViegiThe Economics of the Crisis 15/18 Solutions? Public Policy Externality is solved by public intervention –Solve stock problems first (clean balance sheet of banking system – nationalise banking) –Only than monetary and fiscal policy (to solve the flow problem) will be effective How Does This Affect Our Understanding of Economic Policy?

16. Nicola ViegiThe Economics of the Crisis 16/18 On Prudence Two Principles of Economics Under Uncertainty – Act Conservatively, be prudent – Build Up Insurance against unknowns The Crisis is a direct result of disregarding inter- temporal stability conditions – too much debt, too easy money.

17. Nicola ViegiThe Economics of the Crisis 17/18 An Example: Chile Very Smooth Response to the Crisis

18. Nicola ViegiThe Economics of the Crisis 18/18 An Example: Chile

19. Nicola ViegiThe Economics of the Crisis 19/18 An Example: Chile

20. Nicola ViegiThe Economics of the Crisis 20/18 An Example: Chile Foundation: Fiscal Surpluses In Good Time (If the private sector don’t save, the government should)

21. Nicola ViegiThe Economics of the Crisis 21/18 Conclusions  Origin of the Crisis – unsustainable private sector debt  Strong policy response but slow exit  Prudent economic policy is an insurance in good time to deal with bad ones  Private sector and public sector stability rules not different – do not live beyond your means