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Over-reaction
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Author Topic: Over-reaction  (Read 3954 times)
Current
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« on: July 20, 2009, 06:04:37 EDT »

This is a small attempt to see if anyone is interested in some more discussions.

It seems to me that all around the world governments have over-reacted to the financial crisis.  The stimulus and interest rate policies adopted have been like those that would be expected were unemployment very high.  Unemployment isn't really that high though.  Neither have the falls in GDP being particularly great.

I think that when the dust settles many people will consider what happened a huge mistake.  Western governments and Japan will emerge from it far more indebted than when they began.
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Medivh
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« Reply #1 on: July 21, 2009, 01:49:20 EDT »

To that, I'm pretty sure there's an obvious question:

Would GDP and unemployment figures have been so lightly affected if western governments hadn't done what they did?
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And if i catch you comin' back my way
I'm gonna serve it to you
And that ain't what you want to hear
But that's what I'll do
-- "Seven Nation Army", The White Stripes

So what you're telling me is that LTV's fudge factor means more than it's independent variable?
Yes...
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« Reply #2 on: July 21, 2009, 08:56:45 EDT »

To that, I'm pretty sure there's an obvious question:

Would GDP and unemployment figures have been so lightly affected if western governments hadn't done what they did?
That's a fair point, we can never know with any certainty what might have been.

However, this is the current situation.... The stimulus the US has enacted has not spent a great deal of money yet.  The stimulus bill was to spend $787B, only $28B have been spent so far.  This is a tiny quantity of money in US government terms. The multiplier takes time to act. That is, the government employs group X they are paid and they spend. Group Y earn income from them, but they will only increase their spending once they are sure it's secure.

A lot of money has been spent on bailouts though.  It is hard to get certain data about this.  The biggest bailouts are the term auction facility (TAF), the toxic assents relief program (TARP) and quantitative easing.  The fed have been lending out hundreds of billions every week on this.  Most of this though has been on quite short term loans.  See the Fed news here and here.

However, the Fed also made the decision to pay interest on reserves in October 2008.  The result of this has been a huge increase in reserves.  What the bank have been doing is borrowing from the fed through the facilities I mention above, such as the TAF and keeping the money in reserves earning interest from the fed.  So, rather than borrowing from customers and lending to other customers they are borrowing from the Fed and lending back to the Fed.  They are doing this to keep themselves technically within capital requirements.  See the graphs in this article, which are from the St.Louis Fed.  (The article is not so great, but that has nothing to do with the data).  Notice that the graph of reserves is "excess reserves", those that are not needed to meet regulatory requirements, that makes the graph a bit more alarming than it really is, required reserves are only ~$60B though.

Because of all these complications it is hard to find out what the net change has been.  It seems that there has been a net amount of quantitative easing through these actions, it's very difficult to know how much.

So, what the US government certainly have done is to reduce the interest rate to zero and bail out the wobbliest banks.  The former may have been useful.  It's hard to see if bailing out the wobbly banks has really been helpful.

However the US government, and the other western governments are quite committed to what they are doing.  The stimulus will be spent even if it is after a recovery has begun.  The fed must absorb the losses it will take on the toxic assets it has bought.  That means the fed will probably have to be propped up by the government.

The story of the other western countries is a bit different, but I haven't got time for that here, this reply is long enough already.
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Ibian
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« Reply #3 on: July 21, 2009, 12:57:41 EDT »

I have reservations about the term "crisis". Seems like just another fluctuation to me, not an actual breakdown of anything.

I blame the media for much of it. I doubt i will ever see a headline that says "things are pretty okay".
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Medivh
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« Reply #4 on: July 21, 2009, 21:32:26 EDT »

Current: Considering the current situation was, if you'll allow the simplification, kicked off by a whole lot of people defaulting on ARM loans, stabilising the banks would seem to be the best move in averting the crisis to me. As you say, there has been a lot of work put into, if not actually stabilising the banks, then making them appear stable to the outside world.

And while correlation isn't causation, the fact that the Fed got in on these things nice and early seems to have averted the worst of the crisis. Even so far as to have made people ask the question, "What crisis?" as you and Ibian seem to be doing. Of course, it could be the other way around; people who are saying "We're in a crisis!" are wrong. Given the uncertainty, though, I'd be hard pressed to accept that the actions of the US are over-reactions. My own government, perhaps I'd agree. Cutting $900 checks for no real reason to every taxpayer seems... silly.
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And if i catch you comin' back my way
I'm gonna serve it to you
And that ain't what you want to hear
But that's what I'll do
-- "Seven Nation Army", The White Stripes

So what you're telling me is that LTV's fudge factor means more than it's independent variable?
Yes...
wodan46
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« Reply #5 on: July 21, 2009, 22:42:22 EDT »

You also have to wonder as to what extent the simple promise of the government to spend oodles of money fixing the economy has revived confidence and brought stability.  Nebulous things like that are hard to measure, but may be of great importance.  So long as people believe the government is doing something, it IS doing something.
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The plural of "anecdote" is "anecdotes". Not "data".
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« Reply #6 on: July 24, 2009, 12:52:58 EDT »

I have reservations about the term "crisis". Seems like just another fluctuation to me, not an actual breakdown of anything.

I blame the media for much of it. I doubt i will ever see a headline that says "things are pretty okay".
I think the word crisis is quite appropriate, it is for lots of past "fluctuations" too.  It's quite a normal way to enter a recession.  Conditions in Certain credit markets are very unusual.  Large businesses are going bankrupt.  I think it counts as a crisis, though perhaps not a major one.

Current: Considering the current situation was, if you'll allow the simplification, kicked off by a whole lot of people defaulting on ARM loans,
I don't really agree that it is so clear.  The default rate on many sorts of home loan increased, some more than ARMs.  It's very hard to come up with an exact answer to what happened in 2007-2008.  I have a feeling we will be reading about it in more detail in a few years time.

Pointing just to the increased default rate on ARMs in late 2008 is a bit specific at present I think.

stabilising the banks would seem to be the best move in averting the crisis to me. As you say, there has been a lot of work put into, if not actually stabilising the banks, then making them appear stable to the outside world.
Remember though what the original justifications were.  If the state bailed out the banks then, so it was said we would have working banks doing their job for the rest of the economy.  If the banks went through Chapter 11 bankruptcy then some markets would freeze for a while and a lot of lending would become scarce.

Well, failing banks have been bailed out.  But, since the Fed started paying interest on reserves those banks have kept their assets as Fed reserves, rather than lending them out.  So, from the point of view of the rest of the economy they aren't so useful.

I think it would have been better if the failing banks had failed and been put through bankruptcy quickly as GM was.

And while correlation isn't causation, the fact that the Fed got in on these things nice and early seems to have averted the worst of the crisis. Even so far as to have made people ask the question, "What crisis?" as you and Ibian seem to be doing. Of course, it could be the other way around; people who are saying "We're in a crisis!" are wrong. Given the uncertainty, though, I'd be hard pressed to accept that the actions of the US are over-reactions. My own government, perhaps I'd agree. Cutting $900 checks for no real reason to every taxpayer seems... silly.

I think that each action should be considered quite separately, since they're quite different.  I think the increase in the money supply has been useful, the reduction of rates may have been useful but I'm not sure.  The stimulus certainly hasn't been useful, not yet.  I don't think that the bailing out of banks has been useful in the US.  I think that paying interest on reserves has been destructive.

You also have to wonder as to what extent the simple promise of the government to spend oodles of money fixing the economy has revived confidence and brought stability.  Nebulous things like that are hard to measure, but may be of great importance.  So long as people believe the government is doing something, it IS doing something.

I see you point.  It makes a degree of intuitive sense, but it makes less sense if you read about macro-economic theory.  It's rather hard for me to explain that in only a few words.

The main problem with it is that the theory that stimulus spending and lower interest rates provides growth depends upon economic agents *not* having accurate expectations.  Keynes modeled expectations of consumers and investors in very simple ways.  Modern New Keynesians have made it a bit more refined.

Let's take the stimulus for example.  The stimulus is only a very small proportion of US GDP, less than 1%.  Keynesian economists believe that it will stimulate because of what they call the multiplier effect.  The idea is that the state employees will spend money elsewhere in the private sector.  The private sector will then expand production and that will stimulate further production.  This assumes that decisions are taken on the basis of local information.  (I don't think this is so unreasonable, different sorts of agent such as consumers, workers and businesses are in different situations though).

However, if decisions are taken on the basis of economy-wide information such as future government policy then obviously things are different.  Businesses may not expand employment much if demand for their products increases, because of they may consider that the future will be worse.  Alternatively, they may keep employment high while demand for the products drops because they consider that the future will be better.  Different business and other agents will of course have different opinions.

So, if we have the agent coming up with "consistent expectations" or "rational expectations" of how future policies will effect him then it's only sensible that he would attempt to do that all the time.  However, Keynesian economics doesn't make much sense under that premise.  Even if agents do things that are quite far from rational in the normal everyday sense.
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wodan46
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« Reply #7 on: August 15, 2009, 13:29:37 EDT »

The way I see it, the stimulus, bailout, and cash for clunkers have resulted in a successful prevention of a second great Depression, albeit adding another huge chunk of debt to the national debt.  But that's acceptable, because we'll make the money back once the economy starts growing again.  Also, if certain imbeciles hadn't been making a mess the last 8 years, we wouldn't have had a national debt to add to.

The Dow went from 14,000 to 12,000 over the course of a year, then abruptly plummeted to 8,000 in a matter of days, before dropping all the way down to 6,500 after another 6 months or so.  The following 6 months leading up to present day, its managed to slowly but steadily climb back to 9,500.  I find it doubtful that such a recovery would have occurred without government action and promises of action.
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jerseycajun
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« Reply #8 on: September 03, 2009, 01:27:35 EDT »

The way I see it, the stimulus, bailout, and cash for clunkers have resulted in a successful prevention of a second great Depression, albeit adding another huge chunk of debt to the national debt.  But that's acceptable, because we'll make the money back once the economy starts growing again.  Also, if certain imbeciles hadn't been making a mess the last 8 years, we wouldn't have had a national debt to add to.

The Dow went from 14,000 to 12,000 over the course of a year, then abruptly plummeted to 8,000 in a matter of days, before dropping all the way down to 6,500 after another 6 months or so.  The following 6 months leading up to present day, its managed to slowly but steadily climb back to 9,500.  I find it doubtful that such a recovery would have occurred without government action and promises of action.


Economic policies take years to feel the effect on the street.  Only a small fraction of the stimulus has been spent, and the Cash for Clunkers was successful only in proving that handing out free stuff is popular.  As for making any real headway in making the existing auto industry more economically stable, it's a wash.  Nothing has substantially changed in either the product they make or the price they sell it for between the time the program started and ended.  Even the new government appointed board members of the "new" GM are mostly from existing GM management who only moved up a rung or two.

Structured bankruptcies exist so that assets may be re-allocated more smoothly and the settlement of debt isn't as volatile.  In the case of GM, Chrysler, and AIG, those would take more time than most bankruptcies to settle, but they would be settled.  Keeping the dinosaur on an public trough IV drip indefinitely (and anyone who takes Obama's expression of his desire not to be the CEO of GM at face value doesn't remember or doesn't know of Nixon's promise that the government takeover of the railroads was only temporary - until they become profitable) is not advantageous long term, to be charitable.  There is every temptation for the Federal government to tip the scale in favor of their 'investments' at the expense of the remaining privately managed auto market, until they too will need to be bailed out and co-opted.

Also consider that the more debt we accrue, the higher the interest rate other nations will want to see in order to make it worth it for them to loan it.  The economy has to grow at such a rate not just to overcome the principle, but the increasing interest.  And if  that's accomplished by artificially incentivizing spending in the U.S. market, increasing the odds of propagating further mal-investment bubbles, long term stability and growth is going to be seriously hampered.

Artificial incentives hide bad investments until they threaten to overwhelm, making it harder to find solid ground.
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"If the natural tendencies of mankind are so bad that it is not safe to permit people to be free, how is it that the tendencies of these organizers are always good? Do not the legislators and their appointed agents also belong to the human race? Or do they believe that they themselves are made of a finer clay than the rest of mankind?" — Frederic Bastiat - from The Law

"Government is not reason; it is not eloquent; it is force. Like fire, it is a dangerous servant and a fearful master."  -  George Washington

"Socialism, like the ancient ideas from which it springs, confuses the distinction between government and society. As a result of this, every time we object to a thing being done by government, the socialists conclude that we object to its being done at all. We disapprove of state education. Then the socialists say that we are opposed to any education. We object to a state religion. Then the socialists say that we want no religion at all." - Frederic Bastiat - The Law
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