fe1 leverage and macroeconomics dec 2011

8/3/2019 FE1 Leverage and Macroeconomics Dec 2011

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Leverage,

Finance andMacroeconomics

google EPI chatelain theorie

financiere

Jean-Bernard Chatelain


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Macroeconomics

Macroeconomics: started after the 1929 Crisis.Keynes and others.

National Accounts, macro-economics aggregates

2 separate fields in the 1990s.

- Business Cycles: Pro-market, Competitive Real

Business Cycles, small costs of cycles forrepresentative agent. Y=AKaL1-a

- Growth: Pro-public intervention, Externalities inGrowth models (Paul Romer (1983)). Y=AKL1-a


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The current crisis and

macroeconomics

They say they want a revolution

DSGE models bashing.

Harsh debates (Krugman, Buiter,).

Institute for New Economic Thinking (Soros).


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August

2009


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Macroeconomics in Crisis?

Cover of the Economist, August 2009.

Institute for New Economic Thinking 2010

(videos) financed by Georges Soros.

Failure of the dominant views pre-2007.

Saltwater versus Freshwater 1976 (David Warsh:Knowledge and the wealth of nations 2006):

Krugman versus Lucas,

MIT Harvard versus Chicago


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Highly controversial

In 2009, Paul Krugman (Princeton), Brad

DeLong (Berkeley) and Willem Buiter (LSE)

argued against Robert Lucas (Chicago)that they are also unable to provide

adequatemonetary and fiscal policy

answers to the crisis.


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Why do they?

Guilt by economists misunderstanding of the

upcoming crisis?

Old memories. Fighting back against Lucas

rational expectations?

A new macroeconomic regime with weakly

regulated financial sector?


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Interaction Growth/Cycle

Possibility to disentangle growth componentfrom cycle component frommacroeconomic times series.

Cycles: say 6-8 years.

Recurrent financial crisis and depressioncomes back.

But large Crisis lasts long and affect thegrowth trend, not only the cyclicalcomponent: USA 1929-1946, Japan1990s-2010.


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Plan: 3 parts

1. We have a problem

2. Solutions of yesterday

3. Solutions for tomorrow


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I. We have a problem


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YES,

IT CAN!


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IT: World map showing Real

GDP Growth Rate for 2009


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I. Why it will happen again

tomorrow.We need a reason to do a revolution in

mainstream macroeconomics.

The reason is: It will happen again in thenext 3 business cycles (3x8years).

It : another large world major financial

crisis in developped countries.


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One world crisis every 80

years? Or every three cycles?The low frequency of the last two major world

crisis (1 every 80 years) is related to the stabilityperiod which followed Bretton Woods

(1945-1973).

This period is also related to a great reversal inthe balance of power for promoting international

private banking and international capital flows,with respect to the period 1870-1940.


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to B

Regime B: Strongly regulated international finance.

1.Control of international capital flows.

2.Control of the amount of credit upwards or

downwards by large retail banks in order to limit

bubbles at the national level (strong macro-

prudential policy, credit control).

3.Strong involvement of government or of thepublic sector in the allocation of credit or capital.


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Strengthes/Weaknesses

Regime A:

+ Better allocation of world capital.

- High probability of world (core OECD countries,

NOT the periphery) systemic bankruptcy with

large cost.

Regime B:

- Weaker allocation of world capital.+ Very low probability of world systemic

bankruptcy (including low contagion effects).


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Condition for A to B in 1945

Weak bargaining power of international

banking.

1.Decrease in trade2.Decrease in capital flows (war).

3.Banking Regulations in 1933


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Condition for A to B in 1945

4. War economies and expected

reconstruction economies with strong

involvement of government in the banking

sector and in the allocation of capital.

5. Willingness to move to fixed exchange

rate and international stability for the

western world.

Others


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Conditions from A to B in 2011

Strong bargaining power of international

finance.

None of the former sixth conditions met.Banking sector regulations:

1933 (4 years) : Glass Steagall Act.

2011 (3 years): Basel 3 in the next 8 years.International Coordination issues among

Jurisdictions; Dissents inside Nations.


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Benefits of Opacity

during crisis management (2)Nobody buy losses with probability one originated by a crisis. Opacity allows to

spread those losses in larger portfolios to

investors (return tickets to Jersey for bad

banks ).


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Benefits of Opacity

during crisis management (3)

Opacity on losses allows soft budget

constraints on financial markets with hardimmediate budget constraints. It allows an

optimal timing of annoucement of losses. It

allows gamble for resurrection.

Hence, some regulators may write about

regulation after the crisis


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Low frequency of world crisis:

a Bretton Woods IITo reach a low frequency of world crisis, oneneeds a Bretton Woods IIalong with a greatreversalof the balance of power of internationalprivate banking, limiting its activities.

The (geo)-political conditions for a great reversalwhere built in by 1945. They are very far frombeing built in 2011.

There will not be a Bretton Woods II in the nextyears. The probability of world systemicbankruptcy and related crisis will remainhigh.


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1 decade over 3 ?

A depression: a lost decade.

1/8 decade

Less 3 decades of Bretton Woods1/5 decade

1880-1929: higher frequency: 1/3 cycle


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Not foreseen?

Prior: it is rare (80

years?). Low

probability

The cost is small (cf.

Sweden 1990s

knows better than

Argentina 1990s).

Small costs of

cycles.


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II. Solutions of Yesterday


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Financial accelerator DSGE

Imperfect capital markets with bankruptcy

costs for non financial firms and also for

banks.

Debt backed by collateral valued at next

period asset price.

Next period asset price determined as the

fundamental value of the asset (efficient

market hypothesis).


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Hypothesis: collateral backed

aggregate credit rationing

(t+1: +1 year or +10 years average?)

.

E1Zm

fe1 leverage and macroeconomics dec 2011

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