One thing I haven’t seen commentators focus on in the spate of relatively good economic news lately is the pace of household deleveraging. Household financial obligations are now at 15.48 percent of disposable personal income. This is the second lowest level on record (it was only marginally lower in the 4th quarter of 1980, at 15.35 percent), and represents a dramatic improvement from the pre-financial crisis peak of nearly 19 percent.
Charles Wyplosz on the troubles in Cyprus:
What is new is that bank deposits will be ‘taxed’. The proper term is ‘confiscated’. Like everywhere in the EU, bank deposits in Cyprus are guaranteed up to €100,000. Depositors have arranged their wealth accordingly, only to be told that the guarantee has been changed ex post.
Taxing stocks is optimally time-inconsistent (Kydland and Prescott, 1977). It is a great way of raising money but it has deep incentive effects as it destroys property rights. What is at stake is the credibility of the bank deposit guarantee system throughout Europe.
The system was shaken in 2008 but in the opposite direction. Followed by all other countries, Ireland offered a full guarantee in a successful effort to stem an impending bank run. The cost to the government was such that it triggered a run on the public debt that led to the second bailout after the Greek ‘unique and exceptional’ one.
Andrew Ross Sorkin is less concerned:
While the bailout of Cyprus is a fascinating case study and raises interesting theoretical questions about moral hazard for policy wonks and talking heads, here is the reality: It is largely irrelevant to the global economy. Cyprus is tiny; its economy is smaller than Vermont’s. And the bailout is worth a paltry $13 billion, the equivalent of pocket lint for those in the bailout game.
What we have seen in the last few days is a very serious blunder by European governments that are essentially blackmailing the government of Cyprus to confiscate the money that belongs rightfully to depositors in the banking sector in Cyprus. It is not clear how this can affect in a positive matter the European project going forward.
I just have to add that the fact that Cyprus is small is not particularly relevant – would Californians pay attention if the FDIC decided to suddenly revise the deposit guarantee for banks in Vermont? Might such a move affect depositor incentives across the country? And that’s to say nothing of the fundamental issue of property rights infringement that both Wylosz and Orphanides point to.
Update here: Cyprus rejects EU proposal.
From a great Washington Post profile of Stanley Fischer:
Around the same time, Fischer tackled John Maynard Keynes’s “The General Theory of Employment, Interest, and Money.” “I was immensely impressed,” he said, “not because I understood it but by the quality of the English.”
(ht: Greg Mankiw)
Mark Thoma presented a paper at this year’s ASSA meetings in which he pointed to the importance of economic history:
But why did so few economists warn about the bubble? And more importantly for the model presented in this paper, why did so many economists validate what turned out to be destructive trend-chasing behavior among investors?
One reason is that economists have become far too disconnected from the lessons of history. As courses in economic history have faded from graduate programs in recent decades, economists have become much less aware of the long history of bubbles. This has caused a diminished ability to recognize the housing bubble as it was inflating. And worse, the small amount of recent experience we have with bubbles has led to complacency. We were able to escape, for example, the stock bubble crash of 2001 without too much trouble. And other problems such as the Asian financial crisis did not cause anything close to the troubles we had after the housing bubble collapsed, or the troubles other bubbles have caused throughout history.
Kevin Drum has an interesting take on why macroeconomists can’t seem to agree on even the basics:
Sadly, macroeconomics combines the worst aspects of just about everything. It’s wildly complex. Its fundamental precepts change over time as the basis of the economy changes. Reliable experimental evidence is practically impossible to come by. Even the effect of fairly simple changes to basic quantities—hell, even the direction of the effect—is often contested. And of course, it’s a field that gores just about every ox in existence. So there’s always a ready audience for any result, no matter how strained an interpretation of reality it takes to get it.
Mark Thoma weighs in here. I’d add that, while it’s no panacea, a little more Kindleberger-style economic history may have gone a long way in helping us see, or at least understand, the financial crisis (and macro crises more generally).