Thursday, September 18, 2008

Ask An Economist

As an economist, I get asked about financial crises a lot. And I really don't know much more than the average informed citizen: my branch of economics is not concerned with firm-level finance. Stephen Levitt, of Freakonomic fame, sounds a similar note:
As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven’t got the foggiest idea what this all means. So I did what I always do when something related to banking arises: I knocked on the doors of my colleagues Doug Diamond and Anil Kashyap, and asked them for the answers.
Diamond and Kashyap's response - lengthy but comprehensible - is on Levitt's blog.


David W. said...

if you don't mind my asking what good is an economist if he can't understand the collapse of an economy?

David W. said...

some other questions that an economist should know or i am assuming be able to find out:

what is the current savings to spending ratio in the US? in other words in the 20 years have we overall been spending more than we have saved?

if that is the case, and i read the above article clearly, it seems inevitable that we are in for a long recession, am i correct?

my thinking is if the financial institutions cannot lend money AND american citizens have not saved any money (which means that don't have any capital to start new business or buy new products AND we know the government is in debt to other nations THEN there is no other sources of funding to either spur consumer spending so businesses can make more money and gain more capital to invest in the future AND individuals (who will also be paying the cost of the government's debt) will not have money to start their own private businesses or works IN ADDITION as certain companies collapse this will mean job losses and more defaulted mortgages IN OTHER WORDS we are in a vicious cycle ->

financial institutions lose money b/c of bad mortgages -> they can't provide capital to companies that need the capital to grow the economy through the generation of new innovations -> government provides capitol but that must be payed by individual taxpayers -> individuals have no savings to provide capital AND are losing jobs b/c companies aren't growing or collapsing -> more mortgages default and we are back to step 1

i hope i am being way too pessimistic but unfortunately i don't think i am; i am with my mom we should be prepared for a way lower standard of living in the future; at least chops can be grateful he has a place to live secured, lol

David W. said...

at least when all the baby boomers retire there will be more job opportunities for us...

Chops said...

David -

This isn't a collapse of the economy. You can still buy bread in the supermarket? You didn't lose your job, did you?

This is a collapse within a specific industry. I'm no more qualified to talk about this than to talk about a collapse in the brewing industry or the accounting industry.

As far as a vicious cycle, there's no evidence of that. The evidence is mostly favorable, that we are (still) in the (typical) virtuous cycle that makes our economy a dynamo! Impetus for "consumer spending" don't come from external shocks, they come from people wanting to buy things. Prices might change, but as long as Americans want to buy things and are capable of producing things, we shouldn't see a sustained economic contraction.

The main evidence, actually, against a sustained, permanent contraction is that it has never happened. If you think the current situation is worse than the Depression, the World Wars and the Panics of the late 1800's... yikes. But I don't think this is even as bad as the times after 9/11/2001 (at least not yet), and we'll be just fine.

Lower standards of living are something Christians should practice now. You don't have to wait for an economic crash to live sacrificially.

David W. said...

agreed on your last statement. but u missed my question and argument - what proportion of american spending has been on credit? if the finance industry tightens credit significantly how much will it shrink consumer spending? that's when it will start affecting the economy at large. additionally, i am not arguing this shake up of the finance industry is a depression, i am merely raising the possibility that it has the potential trigger a long, broad recession. in the long run the current market correction of an industry that obviously invested recklessly and is now paying the price is probably a good thing. but could it come at a larger cost to the entire economy. you don't think so; i'm not convinced. i think the very real potential is there. but i don't know how much consumer spending has declined and could decline in the end that is the deciding factor.

now back to my Bible reading and simple living.


David W. said...

now we know how the problem will be solved; the government is just going to buy up the bad debt; i guess the logic there is governments can't go bankrupt. what do u think of government bailouts?

Mike said...

At least all this has shown that free market, small government, and de-regulation FAIL.

The death of the Bush presidency will leave a legacy of neo-regulation and a decay of the free market.