Rethinking Macroeconomics - Financial stability
This is a complicated exposition of Macro and Micro Prudential policy. Its relevance is attested by two stunning graphs. As Haldene says: ' On cost grounds alone, a systematic rethink and reform of regulatory standards has been fully justified. While the costs of the global financial crisis are still being counted, it seems likely they will be the largest since at least the Great Depression. Two approaches are typically used to gauge these costs of crisis: the cumulative loss of output relative to its trend and the cumulative fiscal costs of supporting the financial system.1 Let’s take these in turn.
'Chart 1 looks at the path of output relative to a simple measure of its pre-crisis trend in the US, UK, France and Germany after the Great Depression of 1929 and the Great Recession of 2008. In either case, it is debatable whether estimated “pre-crisis trends” were sustainable, as they may have been artificially inflated by credit booms. Nonetheless, it is clear that the output losses from both crises, relative to pre-crisis trends, have been extremely large and long-lasting. In the US, the level of output is currently around 13% below a continuation of its pre-crisis trend. Ten years into the Great Depression, output was around 28% below its pre-crisis trend. Even if not quite on the scale of the 1930s, the global financial crisis has imposed a huge opportunity cost on US citizens. In the UK, the losses since the Great Recession, currently at around 16% of pre-crisis GDP, are larger than in the US and indeed larger than those that followed the Great Depression. The crisis opportunity costs for UK and euro-area citizens have been the highest for at least a century.
Images not available, but see graph set at end of article linked below.
'Much the same picture emerges if we look at measures of the fiscal cost of crisis. Again, there are a number of methods for gauging this cost. But one simple metric is to look at the pattern of government debt-to-GDP ratios after the Great Depression and Great Recession, recognising that the larger part of the debt sustainability cost of crisis typically arises from the denominator shrinking than from the numerator rising. Chart 2 plots these debt-to-GDP ratios, again for the US, UK, France and Germany.
' It suggests that, in the decade after the Great Depression, levels of government debt relative to GDP had increased by around 28 percentage points in the US, 9 percentage points in Germany, but actually declined in the UK. Since the Great Recession, levels of debt relative to GDP have increased by, on average, 28 percentage points for the same set of countries. The fiscal cost of the Great Recession, at least on this metric, is larger than during the Great Depression.'
These Macro issues will make most readers keen to grapple with what is a long and technical paper. But the detail and the evidence presented is I, suggest, difficult if not impossible for a simple Macroeconomist to follow. I am pleased that such work is being undertaken and also that it is not my field.
Read the full paper here, especially if you are a central banker or a prudential regulator.