Challenges to the Global Economy

author: Martin Feldstein, National Bureau of Economic Research, Harvard University
author: Simon Johnson, Sloan School of Management, Massachusetts Institute of Technology, MIT
published: Jan. 28, 2013,   recorded: February 2009,   views: 38
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If economic analyses earned ratings like movies, this event would receive an X for extremely disturbing. Two of the field’s most prominent voices spare any sugar coating in their unsettling accounts of the world’s unfolding economic crisis.

Martin Feldstein had a hard time choosing which of the innumerable problems to focus on, he admits, but ultimately settles on near-term challenges faced by the U.S. First off, this downturn is atypical; past recessions generally resulted from the Federal Reserve responding to inflation by nudging up interest rates and slowing the economy. This one involves two disparate but interacting problems: “the weakness of aggregate demand and the dysfunctional character of the financial markets.” In laymen’s terms, consumers are declining to spend money, the housing market’s hit the skids; and banks big and small have no clue the value of their balance sheets, so they won’t lend money to any but the best bets. There are some impressive numbers involved: The U.S. GDP is less than $15 trillion. A $12 trillion fall in household wealth (a combination of stock market and housing losses) has entailed a $750 billion decline in GDP.

The government’s attempts to pick up slack in the credit market haven’t to date brought private markets back to life, says Feldstein. “We’re in a very awkward situation, where the Fed is moving well beyond anything a central bank has ever done before to act as a credit provider.” The stimulus package doesn’t come close to addressing the $750 billion hole in our economy: it’s “a poorly designed program that delivers so little bang for the buck.” Turning from “the bleak picture of the U.S. to the rest of the world,” Feldstein sees a chain of events pulling all major financial centers down, leading to “a mutually reinforcing global recession.” The nations most likely to avoid “being dragged down” by this crisis: China and India.

Astonishingly, Simon Johnson promises “to be quite a bit more negative.” The U.S. banking situation “is much worse than what Marty said.” The system needs a complete recapitalization -- a simple solution -- but practically impossible due to “the power of the banking lobby.” Europe’s banking system is even worse off (poster child: Iceland). European bank losses are dragging down not just banks, but entire nations. Their governments can’t pull together fiscal stimulus packages, either. While “Europe is in denial,” emerging markets like Russia have seen their reserves plunge, and are making stark decisions about “which of their people get bailed out.” And don’t think the IMF can come to the rescue; it has a meager $250 billion to loan, and is trolling for additional money from Western pockets, which just now have very big holes in them. Johnson’s grim conclusion: Economists are reaching a consensus about the possibility of a very long period of slow or no growth: “There’s a danger we could lose a decade.”

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