Month of April, 2009

By Kate Bird, Program Leader, Growth and Equity Programme, Overseas Development Institute

We do not yet know precisely how the global financial crisis will affect people in low income developing countries. Information from the ground is partial and hazy. However, a study of ten countries, led by the Overseas Development Institute, shows the crisis is having a dynamic affect. The nature, severity and duration of impact will vary between and within countries, with the sharpest effects in the most globalised developing countries.

Viral Acharya, Matthew Richardson and Nouriel Roubini comment on the financial crisis, and offer recommendations to regulators on how to fix the system. Access the piece in the Financial Times here.

The financial system in the USA and much of Europe had a heart attack in September 2008.  As in the case of a real heart attack, the highest priority has gone to the emergency response and to stabilizing the patient.  Once that is done and the crisis is abating and even to some extent as it is going on, it will be important (economically and politically) for some to focus on two related issues:  What created the rising risk of an attack?  And what combination of actions post-crisis will reduce the risk of a repeat in the future. 

Michael Spence details the necessary steps needed for the Geithner plan to be implemented, and addresses the current criticisms of the plan. Follow the debate over the Geithner plan and comment on Spence's analysis here.

By Viral Acharya and Matthew Richardson

(forthcoming, Critical Review)

Access full length article:

http://growthcommissionblog.org/files/Acharya Richardson Critical Review Article.pdf

There is almost universal agreement that the fundamental cause of the crisis was the combination of a credit boom and a housing bubble.

In the five-year period covering 2002-2007, the ratio of debt to national income increased from 3.75 : 1 to 4.75 : 1. It had taken the prior full decade to accomplish an increase in debt of this magnitude, and it had taken fifteen years prior to that. Moreover, from 2002 to 2007, house prices grew at an unprecedented rate of 11 percent per year.

When the “bubble” burst, a severe economic crisis was bound to come. The median family, whose house was highly leveraged and whose equity represented 35 percent of its wealth, would not be able to continue to consume as it did through 2007. The economy was going to feel the brunt of it.

Aggressive and innovative monetary and financial sector policy actions in developed economies have pulled the global financial system back from the brink of an abyss. But impaired assets are not yet properly valued and neutralized. And new negative feedback loops may be forming between the financial and real sectors. In any case, even after banking circuits are eventually unclogged, confidence restored, and risk appetite revived, the financial euphoria of the recent past is unlikely to revive any time soon. The changed financial landscape has several implications for the developing economies.

It is difficult at this point in time, with little benefit of hindsight, to determine whether we are passing through yet another financial crisis that has punctuated economic history from time to time, or that we are indeed at a turning point that will change macroeconomic policy and management in fundamental ways.

The ‘Great Moderation’ preceding the current crisis turned out to be simply the proverbial calm before the storm. It seems odd, even appalling, that economists, policy makers and multilateral surveillance bodies like the IMF should not have seen the storm coming, especially since the calm was associated with several macro-economic anomalies.