ECONOMY: Global Financial Meltdown

Mark Carney on forecasting failures Few forecast these events .... The reality is that among all the banks, investors, academics and policymakers, only a handful were able to identify ahead of time the causes and potential scale of the crisis. Central banks, ministries of finance and international financial institutions all believed either that risks were being adequately managed or that vulnerabilities lay elsewhere. Around the world, private banks exceeded their regulatory capital requirements. Clearly, though, risks were not being managed properly and capital was inadequate. Remarks by Mark Carney to Women in Capital Markets, Toronto, Dec. 17, 2008.  

Ben Bernanke on recession risk Senator, the usual context of this question is, “Does an inverted yield curve presage a recession or a slow-down in the economy?”... Just very quickly, though, on the forecasting power of the yield curve, there’s been a good bit of evidence that declines in the term premium and perhaps a great deal of saving, chasing a relatively limited number of investment opportunities around the world, have led to a somewhat permanent flattening, or even inversion, of the yield curve, and that that pattern does not necessarily predict slowing in the economy or a recession. Ben Bernanke explaining to Congress in February, 2007, that eight months of an inverted yield curve (short-term interest rates above long-term rates) do not mean a recession is likely.

Mark Carney on the ‘paradox of thrift’ Two topical fallacies of composition illustrate the point. The first is what Keynes termed the “paradox of thrift.” It may be individually rational for people to want to save more and businesses to invest less during uncertain economic times. If this behaviour is widespread, however, it becomes collectively irrational. Fear of recession feeds a recession. Similarly, a bank may decide to hoard capital in anticipation of increased loan losses during a slowdown. If all banks do the same, their actions will exacerbate the downturn and increase their eventual losses. It is well-known that timely and properly calibrated monetary and fiscal policy can address the first issue. It is less widely recognized that macroprudential regulation can address the second. Remarks by Mark Carney, Toronto, Dec. 2008.

Ben Bernanke on monetary policy A main bulwark against deflation in the United States ... is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation .... I am confident that the Fed would take whatever means necessary to prevent significant deflation ... [even] a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition ....  

Under a fiat (that is, paper) money system, a government (in practice, the central bank in co-operation with other agencies) should always be able to generate increased nominal spending and inflation .... U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost ....  

The logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation .... By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation ....

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

From Deflation: Making Sure ‘It’ Doesn’t Happen Here. Remarks by Ben S. Bernanke before the National Economists Club, Washington, D.C., Nov. 21, 2002.

Donald Coxe: a 35-year veteran of the Canadian investment community

I have seen the economy in worse shape... I can tell you that the economy was in worse shape in 1974 and 1975. The early '80s, when [former U.S. Federal Reserve governor] Paul Volcker had to end the inflation spiral and interest rates got to 20%, was also a very bad time. Those were two scary times, and I am a survivor of both. These days I find myself spending a great deal of time dealing with people who, coming into the business much later than I did, think the only comparison now is with the Great Depression… During the 1981-'82 cycle, interest rates were 20% compared to now where they are zero. Obviously that's a dramatic difference.

[Source: Financial Post]