Wednesday, February 18, 2009

Hausmann on the global financial crisis

Hausmann has a nice piece on the VoxEu website about the global financial crisis and how global and regional multilateral institutions can help the developing countries cope with the fallout of this crisis on their economy (basically, by stepping up lending and widening their scope and role). He uses the fan belt analogy (I think this one is his favorite as he uses this one in the growth diagnostics studies as well)!

When the fan belt of the car breaks, the engine overheats, seizes, and stops. A new fan belt is no longer enough for a solution. If the Wall Street is the belt, Main Street is the engine. Since the engine has seized, even fully capitalised banks will be weary to lend into a downturn, and firms and households would be unwise to borrow, even if credit was available. Credit crunches often lead to recessions, but the eventual recovery has never been lead by credit, as Calvo, Izquierdo and Talvi (2006) have shown for emerging markets.

A more sustainable complementary alternative is to use the super-borrower capacity to reflate the global economy and to reestablish financial links globally. This can be done in several ways.

First, multilateral development banks should be recapitalised –by issuing guarantees in the form of callable capital – allowing them to raise funds in global capital markets to on-lend to the developing world.

Second, the IMF should also be recapitalised, possibly through an issuance of SDRs, so as to make sure that the organisation has more than enough funds to help reconnect countries to finance.

See my earlier discussion about the fallout of the global financial crisis on the developing countries here.