Justin Yifu Lin and Volker Treichel argue that it is not the global imbalances, but excess demand in the US that caused the global financial crisis. Here is an abstract of their recent paper:
The world is currently still struggling with the aftermath of the worst economic crisis since the Great Depression. Following a description of the eruption, evolution and consequences of the global crisis, this paper reviews alternative hypotheses for the causes of the global financial crisis as well as their empirical evidence. The paper refutes the frequently voiced view that the global crisis was caused by global imbalances that reflected economic policies of East Asian countries. Instead, it argues that global imbalances were the result of excess demand in the United States, resulting from both the public debt in the United States arising from the Afghanistan and Iraqi wars and tax cuts and the overconsumption by households supported by the wealth effect from the housing bubble in the United States. The housing bubble itself was the outcome of the Federal Reserve's low interest rate policy in the aftermath of the burst of the "dot-com" bubble in 2001, the lack of appropriate financial regulation, and housing policies aimed at expanding the mortgage market to low-income borrowers. It was possible to maintain the large trade deficits of the United States for such a long period of time because of the dollar's reserve currency status. When the housing bubble in the United States burst, the global crisis ensued. The paper also analyzes why China's trade surplus increased significantly in general and with the United States in particular in recent years, and argues that this increase was caused by both the relocation of the labor-intensive tradable sector of East Asian economies to China and high corporate saving rates in China as a result of its dual-track approach to reform.
From NepaliEconomy.com:
ReplyDeleteThe Global Imbalance arugment for the financial crisis was made by the current Fed Chairman Bernanke. But there is NO definitive answer IMHO - there is a cottage industry trying to explain the reasons. In my view financial crisis happens whenever the deeply held views by investors are turned upside down - the Tulip Bubble in the 16th century being the case in point. In the case of the US, nobody including the Fed Chairman Greenspan believed that housing price will turn negative (it had never done so in the post-war years). When it did, there was a crisis.
Just recent examples:
1980s: Latin American Debt crisis (deeply held view: sovereign countries do not default)
1990s: Russian debt crisis (deeply held view: nuclear powers do not default)
1990s: Asian financial crisis (deeply held view: hot money and FDI will always flow to SE Asia because it is where the growth is)
2000: Tech bubble burst (deep held view: it's a different paradigm i.e. it's different this time)
Future financial crisis:
1) Euro zone breaks up in a disorderly fashion
2) China goes into a recession i.e. negative growth.
NepaliEconomy.com
Thats true. And, the reasons have been well explained by so many researchers (I have cited plenty of them in previous blog posts). I think the main point here is not what caused it but what triggered it at the moment. Efficient Market Hypothesis worked fine when everyone believed on it and thought every thing worked fine. Global imbalances contributed to building up the momentum up to the tipping point, but it was the downturn in housing markets that might have triggered the entire crisis. Thats the point when investors' belief on EMH got shattered (forcing Greenspan to contemplate if his belief in the markets was mistaken).
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