Arnold Kling  

Banana Republic Economics, Continued

Theory, Explanation, and Polic... Lectures on Macroeconomics, No...

Carmen Reinhart and Ken Rogoff write,

We find that banking crises almost invariably lead to sharp declines in tax revenues as well significant increases in government spending (a share of which is presumably dissipative). On average, government debt rises by 86 percent during the three years following a banking crisis. These indirect fiscal consequences are thus an order of magnitude larger than the usual bank bailout costs that are the centerpiece of most previous studies. That fact that the magnitudes are comparable in advanced and emerging market economies is also quite remarkable.

They are looking at a multi-country historical sample of banking crises going back two hundred years. Interestingly, they find a housing cycle associated with banking crises. Not surprisingly, they find that sovereign debt crises often follow banking crises. However, defaults are an emerging-market phenomenon--one might say that developed countries no longer default (which may be like saying that house prices never decline).

Read the whole thing.

COMMENTS (4 to date)
winterspeak writes:

Arnold: Rising public deficits through reduced tax revenue are the automatic stabilizers that kick in when aggregate demand falls.

Public (Federal) debt is required for net private savings.

Deficit spending will get us here faster. The best form of deficit spending in the US is for the Fed to declare a payroll tax holiday. But you can do it the slow way and let the deficit slowly grind up until it's large enough to satisfy the private demand for net saving.

Tom Grey writes:

The theory: PQ went up too much because the derivative expansion, outside of Fed control, increased the V velocity (fudge factor) of Money on the MV side.

Some $6 tr in 'house value', and between $20 tr (Brad DeLong's number) and maybe $60 tr of other global paper wealth has disappeared.

Economics has never seen this phenomenon before; altho LTCM should have been one warning (be 'too big to fail' and you'll get bailed? Yes! Lesson learned!)

Huge deflation is coming, unless the economy is re-flated.

Print money. Not tax, not borrow, just print it.
Do not fear inflation until it starts up again.

OK, maybe better would be to send out an IRS credit card with a $10 000 credit limit to all tax-filers, allowing them to borrow at current Fed rates (of 1%) in an AR, but subject to IRS collection in the future.

Merry Christmas. In Slovakia, Catholics say that Jesus brings the presents ... St. Nicholas having brought goodies on his name day, 6 Dec.

Methinks writes:

Interestingly, they find a housing cycle associated with banking crises.

In the United States, the mortgage market is the largest single segment of the entire fixed income market, accounting for approximately 25% of the total debt market. If the mortgage market is similarly large in the other examples in the study, it makes sense to me that housing cycles are linked to bank crises.

I look forward to reading the rest of the paper over the holidays (so forgive me if this is covered), but I wonder if housing cycles are historically accompanied by tightening credit spreads on all debt. Credit spreads for all debt across the globe were at unprecedentedly tight levels only weeks before the poo hit the fan in the summer of 2007.

8 writes:

How about the demographic component to all of this? It seems previous crises occured after major wars which decimated the working age population. We've done the same in the developed world through contraception, it just took a little longer.

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