An empirical analysis of what went wrong

Via Paul Krugman, a paper by John Taylor (he of the Taylor rule fame) from last November examining the early part of the credit crisis in the US. It is somewhat technical but still readable by a layman, it’s worthwhile ploughing through because he takes a look at the policies pursued by the US Government and their outcomes. His assertion that the Lehman bankruptcy didn’t matter as much as convential wisdom would have it has been challenged but I think there is something in the idea that inconsistent action has excaberated problems:

    In this paper I have provided empirical evidence that government actions and interventions
    caused, prolonged, and worsened the financial crisis. They caused it by deviating from historical
    precedents and principles for setting interest rates, which had worked well for 20 years. They
    prolonged it by misdiagnosing the problems in the bank credit markets and thereby responding
    inappropriately by focusing on liquidity rather than risk. They made it worse by providing
    support for certain financial institutions and their creditors but not others in an ad hoc way
    without a clear and understandable framework. While other factors were certainly at play, these
    government actions should be first on the list of answers to the question of what went wrong.

    What are the implications of this analysis for the future? Most urgently it is important to
    reinstate or establish a set of principles to follow to prevent misguided actions and interventions
    in the future. Though policy is now in a massive clean-up mode, setting a path to get back to
    these principles now should be part of the clean-up.

One final thing — there is a blink and you’ll miss it reference to the Republic. Check out the eye popping location of “IRL” on the chart on page 6.

  • Greenflag

    Kensei ,

    ‘there is a blink and you’ll miss it reference to the Republic. Check out the eye popping location of “IRL” on the chart on page 6. ‘

    So too did Taylor 😉 or else I’m reading the chart wrong . The IRL dot is I estimate about 6 points above whereas Spain the (largest in Taylor’s words is at 2.5 ). In Taylor’s lingo
    2.5 > 6 ?

    Be that as it may Taylor has a point that so called sovereign Governments are not without guilt in both the creation of this crisis and their initial botched responses to the ‘liquidity’ crisis . It’s now belie ved that Paulson virtually gave away half Bush’s initial 700 billion dollar stimulus to help so called strap cashed banks pay out large bonuses and use the cash to bolster their balance sheets and buy out their ‘weaker ‘ competitors .

    There is no point in having Government control of the banks i.e ‘nationalisation’ if the regulatory agencies supporting such are toothless tigers and I mean of the non celtic variety ;).

    We await the April G-20 for ‘new ‘ initiatives to restore confidence to the world’s banking system .

    In the real world ‘manufacturing ‘ employment in the USA is down to 11.5% from 20% a decade ago . In the UK it’s down to 14% from 24% back in 1990 and in Germany it’s still 23% approx .

    Where are the replacement jobs now that ‘financial services ‘ are in rapid retreat overseas and how can a services economy hope to generate the ‘foreign ‘ exchange needed to maintain the value of the pound or dollar ?
    As I’ve said in earlier posts this crisis is not just ‘financial ‘ or based on the property meltdown although on the face of it they are the front page and academic favourites for ‘discussion’ and debate . At a ground level what is happening is the lowering of living standards by almost ‘darwinian ‘ mechanisms of the ‘developed’ western worlds living standards and future expectations .

  • dewi

    Some light relief – thanks Kensei. Read once….but need to read again.

  • Greenflag

    Kensei & Dewi

    There are some excellent articles in Monday’s (9th March ) Financial Times on the crisis of ‘capitalism ‘

    Martin Wolf’s ‘Seeds of it’s own destruction’ gives a lucid description of the mess.

    Robert Shiller’s ‘A failure to control animal spirits ‘ looks at the crisis from a human behaviour aspect.

    Wolfgang Munchau’s piece on the L ‘curve ‘ of this recession as opposed to a more normal V or U curve is ‘disturbing ‘ .

    Well worth a read if you want to get to grips with the current state of play .

    Yesterdays edition had Gillian Tett’s ‘Lost through destructive creation’ which I’ve still to read 🙁