The Cat in the Tree and Further Observations: Rethinking Macroeconomic Policy
IMF Blog, May 1, 2013
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Bibliographic details
- Authors: George A Akerlof
- Published: May 1, 2013
Metaphor and framing
- Author frames the crisis as a cat in a huge tree: visible, alarming, and subject to many different perspectives.
- Each analyst offers a valid, perspective-driven image of the cat; the conference’s value is in the variety of these perspectives and occasional convergence.
- Focus of the essay: post-crisis United States, with analysis that also pertains internationally.
Historical evidence on financial recessions and credit
- Jorda, Schularick, and Taylor study: 14 advanced countries from 1870 to 2008; recessions divided into financial recessions and normal recessions.
- Key empirical finding: financial recessions are deeper and slower in recovery than normal recessions, and recovery is slower the greater is the credit to GDP ratio.
- Application to the current crisis:
- Using bank loans to the private sector as the measure of credit, the United States’ recovery is about 1 percent of GDP better than mean recovery for financial recessions.
- When credit also includes shadow banking system credit, the United States is about 4 percent better than the median recovery in financial recessions.
- Caveat: With the onset of financial derivatives, measuring “credit” becomes ambiguous; inclusion or exclusion of derivative-related exposures affects comparisons to historical benchmarks.
Role of derivatives and the shadow banking system
- Two possible roles of derivatives:
- If used to hedge risk, derivatives could be expected to soften the crash.
- If they escalate gambling, derivatives could be expected to exacerbate the crash.
- Conventional interpretation of the 2007-2008 crash: derivatives enhanced gambling by enabling a daisy chain of escalating valuation of mortgages, with shoddy originations bundled into derivative packages rated A and higher.
- Consequence described: mortgage originators had reduced incentives to require downpayments or borrower credibility; investment houses and ratings agencies relied on reputational fiduciary roles in creating and rating derivatives.
- Implication: measures of credit based solely on loans outstanding, even when including shadow banks, likely yield a conservative benchmark for where recovery should have been.
Assessment of macroeconomic policy response
- Context in Fall 2008: without government intervention, the Great Depression was the benchmark for potential outcomes.
- Author’s assessment: macro policy after the crisis has been “truly excellent” and close to what was required to avert a repeat Depression.
- Specific policy actions cited (examples of measures implemented):
- The Economic Stimulus Act of 2008
- The bailout of AIG
- The rescue of WaMu, Wachovia and CountryWide by adoption
- TARP
- The stress tests run by Treasury and the Fed
- Declines in interest rates to close to zero
- The American Recovery and Reinvestment Act of 2009
- Bailout of the auto industry
- International co-operation at the Group of Twenty Meeting in Pittsburgh with IMF participation
- Intuitive argument for effectiveness: targeted interventions can prevent systemic collapse — e.g., if Lehman Brothers had been $1 in the red and needed $1 to stay solvent, a $2 intervention at the right moment could have averted a Great Depression-style outcome.
- Magnitude claim: expenditures for bailouts stopped a financial meltdown; relative to the tens of trillions of GDP that would have been lost with a repeat of the Great Depression, the savings from TARP are of the order of magnitude of 1,000 to one — a figurative “finger in the dyke.”
- Fiscal stimulus multipliers:
- Current estimates of government expenditure multipliers are something like 2.
- Liquidity-trap estimates of a balanced budget multiplier are approximately 1, in theory and in estimation.
- The tax multiplier is robustly measured as approximately 1.
- Therefore, government expenditure multipliers will be the sum of the two, supporting the conclusion that stimulus bills have almost surely had significant payoff.
Criticism, communication failure, and lessons for the future
- Main criticism: policymakers and economists failed to lead the public to understand that success should be measured against a benchmark accounting for financial vulnerability set in the preceding boom, not solely by the level of current unemployment.
- Communication challenge: the public has limited attention for macroeconomic history and complex benchmarks.
- Summary judgment:
- Economists did poorly in predicting the crisis.
- Post-crisis policies, however, have been close to what a sensible economist-doctor would have ordered, implemented by Bush and Obama administrations and supported by Congress.
- Lesson: good economics and common sense have worked well in crisis response; the record of trial and success should inform policy going forward.
George A. Akerlof, May 1, 2013
Content in this bundle
- 从树上的猫说起：反思宏观经济政策; iMFdirect博客 2013年5月1日, 特约撰稿人：George A. Akerlof 加州大学伯克利分校
- 世界金融危機のさらなる考察: マクロ経済政策の再考; iMF direct ブログ 掲載2013年5月1日, 寄稿：ジョージ・A・アカーロフ, カリフォルニア大学バークレイ校
- Кошка на дереве и другие наблюдения: переосмысление макроэкономической политики
