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Dr. Miguel A. Alonso
Dr. Miguel A. Alonso Neira
Associate Professor
Applied Economics I Department
University Rey Juan Carlos
Dr. Miguel A. Alonso
 The paper presented by Professor Michael Bailey is a very
smart and well written article.
 It shows three political economic paradigms that could be
followed in the near future by President Obama.
1. The New Deal’s/ neokeynesians paradigm (more
interventionist).
2. The Clinton’s paradigm (less interventionist)).
3. The behavioral economics paradigm.
 However, for the sake of completeness, let’s deepn in fourth
approach: the Austrian School approach (laissez faire).
Dr. Miguel A. Alonso
 This approach will be very useful to complete the ideas
developed in this paper, specially those related to:
 The origins of the current crisis: Market failure vs
bad economic policies, institutions, and intervention.
 The economic policies adopted by developed
countries to counter the effects of the financial and
economic crisis.
 What could be done to overcome the crisis? More shortrun intervention and public spending vs market
adjustments.
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Dr. Miguel A. Alonso
 The current crisis has multiple causes. In the United
States, the most important were the following:
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1. Since 1995, the very lax monetary policy of the FED
encouraged the dot.com and the housing bubbles (and
subsequent burst).
Tasa de crecimiento interanual de la M2 y de la M3 (Estados Unidos)
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12
10
8
6
4
2
Dot.com
NASDAQ
Dot.com
Crisis
NASDAQ
dot.com
0
-2
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
M2
M3
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Dr. Miguel A. Alonso
1. Since 1995, the very lax monetary policy of the FED
encouraged the dot.com and the housing bubbles.
 Over decades, expansive monetary policy has gone
hand in hand with implicit and explicit bailout guarantees
(Moral Hazard) and this has distorted the process of
capital allocation.
 The behavior of the investment community reflects the
incentive structure put in place by the authorities. The
problem arises when this behavior becomes systemic.
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Dr. Miguel A. Alonso
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1. Since 1995, the very lax monetary policy of the FED
encouraged the dot.com and the housing bubbles.
 Effects of the expansionary monetary policy were:
a) Excessive risk taking encouraged by artificially low
interest rates. (Market failure or excessive monetary
intervention?)
Desviación de los tipos de interés respecto al tipo implícito en la regla de
Taylor: i -i (TR )
2
1
0
-1
-2
-3
-4
-5
2000Q1
2001Q1
2002Q1
2003Q1
2004Q1 2005Q1
US
2006Q1
Euro Area
2007Q1
2008Q1
2009Q1
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2
Dr. Miguel A. Alonso
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1. Since 1995, the very lax monetary policy of the FED
encouraged the dot.com and the housing bubbles.
 Effects of the expansionary monetary policy were:
a) Excessive risk taking encouraged by artificially low i.
b) An increasing CA deficit (the mirror of I-S<0)
Estados Unidos
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20
U.S. requires
international
funding.
(China)
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10
5
0
-5
-10
1990
1992
1994
1996
1998
2000
2002
2004
2006
Diferencial
Investment
Gross national savings
Current account balance
2008
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Dr. Miguel A. Alonso
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1. Since 1995, the very lax monetary policy of the FED
encouraged the dot.com and the housing bubbles.
 Effects of the expansionary monetary policy were:
a) Excessive risk taking encouraged by artificially low i.
b) An increasing CA deficit (the mirror of I-S<0)
c) A distorsion in the capital structure of the economy.
Misleading interest
rates: excess of
investment and bad
investment process
Excess of
demand of
current goods
Bad investement process and
overinvestment
Extension of the early stages of the production
process to the detriment of the latest
Value of
final
consumption
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Dr. Miguel A. Alonso
 The current crisis has multiple causes. In the United States,
the most important were the following:
2. Pressures that many bureaucrats and public agencies
exerted on banks to lower lending standards on mortgages.
 Under the revision of the CRA in 1995, GSE Fannie
Mae and Freddie Mac were pressured to expand and buy
mortgage-backed securities.
 Under these pressures, in 2007 FM and FdM financed
four out of five mortgages in the US.
 Before the crisis started, the American mortgage market
was a paragon of intervention and socialism.
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Dr. Miguel A. Alonso
 The current crisis has multiple causes. In the United States,
the most important were the following:
2. Pressures that many bureaucrats and public agencies
exerted on banks to lower lending standards on mortgages.
 Under the revision of the CRA in 1995, GSE Fannie
Mae and Freddie Mac were pressured to expand and buy
mortgage-backed securities.
 Under these pressures, in 2007 FM and FdM financed
four out of five mortgages in the US.
 Therefore, it is undeniable that subprime mortgages
grew under the consent –or the apathy– of the American
authorities. (Market failure or excessive market
intervention? What about the Glass-Steagall Act?)
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Dr. Miguel A. Alonso
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 An historical research conducted by C. Reinhart and K.
Rogoff shows that financial crises are usually followed by
government-debt crises.
 This process starts as
private debt is shifted onto
the balance sheet of the
government (bailout).
 Then, the problem is
made worse as a result
of an increase in
unemployment benefits
and keynesian policies.
Banks
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United States
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Spain
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Dr. Miguel A. Alonso
 These graphs make us aware of some of the costs of keynesian
fiscal stimulus: they clearly displays how a short-run fix turns
out to be a long-term problem.
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Dr. Miguel A. Alonso
 In the long-run, several major economies –the US and the UK
– could see their fiscal position severely deteriorated.
 According to the Report on Global Sovereign Credit Risk, the
Sovereign Debt of these countries has deteriorated significantly.
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Dr. Miguel A. Alonso
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 The market for credit default swaps (CDS) shows that both the
US and the UK “were among the worst performing sovereign CDS”
at the end of 2009. Concerns are mounting about the increase of
debt/GDP ratios.
Higher
default risk
Highest
Higher default risk
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Dr. Miguel A. Alonso
 The weakening of the Western countries’ fiscal position,
has provoked a political debate on the urgent need for
fiscal consolidation.
 By tightening fiscal policy too late, developed world
governments could make things much worse.
 Currently, in the
US public borrowing
is crowding out private
investment, making
harder the economic
recovery.
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 This will put pressure on the
FED to “accommodate” the
increasing public borrowing
(bond issuing) by printing even
more money. So the US dollar
would be weaker in the future.
Dr. Miguel A. Alonso
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Dr. Miguel A. Alonso
 Reinhart and Rogoff again warn us: history shows that high
levels of public debt are accompanied by low growth rates.
 President Obama’s growth projections are too
optimistic, because of a fake recovery based on short-run
monetary and fiscal expansions.
 Most of the the measures initiated in response to the
crisis, have at best only delayed unavoidable real corrections.
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Dr. Miguel A. Alonso
 We have seen all this before. In the 1990s, the Japan’s
government socialized private losses through a massive transfer
of private debt to the national balance sheet.
 This happened in the wake of the Japanese asset bubble, and
led to a decade of slow growth and a lack of restructuring of the
economy.
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Dr. Miguel A. Alonso
 We have seen all this before. In the 1990s, the Japan’s
government socialized private losses through a massive transfer
of private debt to the national balance sheet.
 This happened in the wake of the Japanese asset bubble, and
led to a decade of slow growth and a lack of restructuring of the
economy.
“With the U.S. government stepping in to keep markets from
clearing, today's U.S. economy in many ways resembles the
post-bubble Japanese economy of the 1990s. Ultra-loose
monetary policy and low demand for credit, combined with
high unemployment and consumer deleveraging, could lead to
a prolonged slump”. Christopher Wood (Wall Street Journal)
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Dr. Miguel A. Alonso
 The increasing deficits and a growing national debt burden
on the one hand, and the lower growth rates on the other,
could lead into a vicious cycle, whereby investors become
more reluctant to put their money into US treasuries.
THERE IS NO SUCH THING AS A KEYNESIAN FREE LUNCH!!!
 In this context, Obama’s Health Law emerges (not a good
moment).
 R. Higgs: “the reform of the health system
in the US will be a disaster, not only from the
point of view of this specific sector/industry,
but also from the perspective of Government
finances.”
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Dr. Miguel A. Alonso
Source: A Citizen's Guide to the 2009 Financial Report of the U.S. Government
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Dr. Miguel A. Alonso
Source: A Citizen's Guide to the 2009 Financial Report of the U.S. Government
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Dr. Miguel A. Alonso
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Dr. Miguel A. Alonso
 The ABCT makes a distinction between the “primary” and
“secondary” depressions. The secondary depression is the
turmoil in the financial markets. However, the underlying cause
is the distortion of the economy’s capital structure: the primary
depression.
 As long as governments and CB continue to focus on the
financial symptoms of the “secondary depression” and
continue to ignore the structural aspects of the “primary
depression”, they act like the old doctors of the Middle Age.
 An appropriate policy would be to liberalize the economy
at all levels to allow the rapid reallocation of productive
factors to profitable sectors.
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Dr. Miguel A. Alonso
 On of the biggest threats facing the American economy, is
the massive buildup of paper bank reserves.
 The banks are still holding on to these reserves. But, when
they start lending again, the result could be hyperinflation.
 Hence, the priority of Obama’s Administration should be
to find some means for withdrawing those reserves from the
banking system avoiding future problems with the dollar.
 It would be essential to reduce public spending and taxes,
in order to increase the available income of heavily indebted
economic agents who need to repay their loans.
 Finally, we need to encourage the accumulation of real
saving, stimulating a process of deleveraging in the economy.
Dr. Miguel A. Alonso