(A condensed version of this post appeared as my MINT column today)
The acknowledgement starts with the email from friend Hemant Takalkar on a Saturday morning. That email took me to the CafeHayek link, to Clive Crook’s blog at The Atlantic, to Marginal Revolution’s blog post, to Paul Krugman and Robin Wells’ critique of Raghuram Rajan’s ‘Faultlines’ and to Raghuram Rajan’s response to their critique here.
Now, I have not read the book, ‘Fautlines’ yet, though I have a copy of it. After a point, I felt saturated reading and discussing the financial crisis of 2008. Wanted to avoid indigestion and hence kept the book in reserve for reading, by the bedside. But, I keep reading Raghuram Rajan’s articles and have blogged on them almost always.
On balance, I tend to side with Raghuram Rajan (RR) in this exchange with Krugman and Wells (KW). In their critique, KW had politicized the matter by stating that RR has been critical of democrats. Economists can find common ground or at least zero in precisely on where they differ only if they stick to facts, interpretations rather than on motivations. It should be possible to verify whether Freddie Mac and Fannie Mae contributed to the sub-prime bubble. There is no need to argue on facts.
Global factors can co-exist with local causes
KW are on a strong wicket when they point to the global nature of the bubble. Hence, there is some merit in seeking to find a common ground for the global bubble rather than on the US causation alone. But, bubbles could have both common and idiosyncratic grounds. Idiosyncratic reasons might have aggravated the global causes. Further, in their absence, they could have muted the global causes. Hence, focusing on the global cause does not preclude and cannot preclude finding local causes.
It is somewhat disappointing to note that KW find the only global cause to be the global savings glut. That is too easy and absolves several others of responsibilities for the crisis.
Yes, one can always trace the 2008 crisis to the decision of China to devalue the renminbi by 45% on December 27, 1993. From there, (among other things) flowed Asian trade and current account deficits, the Asian crisis, the exchange rate devaluation, the Reserve Accumulation, the investment of those reserves in US Treasuries and Agency debt by foreign central banks, the impact of that on US interest rates (it caused them to drop), the US lending boom and borrowing binge, and bingo the crisis.
In fact, this line of reasoning can be immediately faulted. It does not explain the housing boom and bust in some European countries and elsewhere. Global savings glut seems to have played a role only in the US!
Very significant domestic factors at work in the US
To come back to the culpability of several others – was it correct on the part of President Bush to have urged Americans to go and shop in the wake of 9/11? Was it correct on the part of Chairman Greenspan to have sided with Republican tax-cuts, relying on unreliable estimates of future fiscal surpluses? Was it correct on the part of Summers and Rubin to have blocked regulation of derivatives trading and to have brushed aside Ms. Brooksley Born? Was it correct on the part of Greenspan and Bernanke’s Federal Reserve to have kept rates so low for so long and to flag their increases well in advance, for two years? What did it do risk attitudes on Wall Street and elsewhere?
To acquit the Federal Reserve is astounding
The free pass that KW give to the monetary policy behaviour of the US then and now is a hard one to swallow. RR is correct that the European Central Bank was only marginally different from the Federal Reserve in policy easing. I have shown a slide in numerous speeches in the last several years that showed how real short rates were well below long-term average for the US, Europe, Switzerland and Japan (not to mention UK, Australia, etc.) in 2001-04.
Now, the question to ask is why did all of them engage in exceptional policy loosening? Clearly, the chief reason is that they were reacting to the Federal Reserve stance. Had they not done so, their currencies would have appreciated even more than they did, vs. the US dollar. The Federal Reserve thus not only engineered a very loose monetary policy for the US but also for the world, given the role of the US dollar as the global reserve currency.
The world was and still is on a de facto dollar standard. That is what enables America to export its bubbles to others (Japan in the 1990s is an obvious example). Failure to recognize and admit that is a significant and deliberate omission.
Further, in calling for loose fiscal policy focused on job creation for a short-term fix might be acceptable if there is also a willingness to accept the need for long-term solution such as increase in savings and investment. That is not there. Certainly, negative real rates do not encourage de-leveraging and saving. If the American public is still trying to save and pay down their debt, then it shows their wisdom but it does no credit to US policymakers who only pay lip service (Mr. Geithner’s latest testimony to the US Congress on China’s currency policy is an example of such lip-service) to encouraging savings. Cash for clunkers was certainly not an inducement to save.
One only has to look at the global bubbles building up in 2010 to understand the evils of the current interest rate regime in the West and exchange rate regimes in the East. It is amazing that we are writing about acknowledging, accepting and understanding the consequences of ultra-loose monetary policy, barely two years after the crisis of 2008 caused by such policies practiced from 2003-07.
To blame one without acknowledging the other as both the East and the West are doing might be fair game in geo or local politics but is not recommended practice for academics.