Where Danger Lurks

Editorial Reviews

Your risk from a texting driver, a legal gun owner or a lightning strike is higher. Your risk, however, from under-regulated industry, of the type that caused the Texas explosion, the massive oil leaks that happened recently from pipelines in Arkansas and Texas, not to mention the Deepwater Horizon explosion that dumped over million gallons of oil into the Gulf of Mexico as well as claiming the lives of 11 rig workers, is far, far greater. In response to the devastating human and natural costs of under-regulated industries and corporate greed we have…a continued call for less regulation, and less money spent on enforcing the regulations that remain.

If we really cared about addressing real dangers we would have applied the trillions of dollars that have gone to wars in Iraq and Afghanistan to developing and promoting renewable energy and fighting the effects of climate change. If we really wanted to make our citizens safe, we would be holding the corporate perpetrators of natural and human disasters responsible, and working to see that safety regulations were followed in a way that would prevent future disasters.

But we are bound to a national narrative that tells us that we can combat the bad guys by putting more guns in the hands of the good guys. But we seem to just accept the fact that corporations will do whatever they can to maximize profit, and the costs that all of us must bear are somehow simply the price of doing business. Sure, I want to know why the Tsarnaev brothers committed their terrible acts of violence.

Where Danger Lurks

And I get that we are fascinated by the rare individual who commits unimaginable acts for unimaginable reasons. We already know why West Fertilizer Co. And it is that prosaic, everyday pattern of choosing short-term profit over life and health that I find truly terrifying. This content is cross-posted on the UU Collective , a Patheos blog.

Join our community to cultivate wonder, imagination, and the courage to act. Twitter Youtube Facebook Rss Mail. Where Danger Lurks April 24, 24 Apr Lynn's first book of poetry, Blessing the Bread , earned her fans around the world. In her professional life she serves as a minister for the Church of the Larger Fellowship. In her free time she trains dogs for competition in obedience, agility and canine musical freestyle dancing with dogs.

The result was a financial structure that was increasingly exposed to potential shocks. In other words, the global economy operated closer and closer to the dark corners without economists, policymakers, and financial institutions realizing it. This in turn led to major liquidity runs, not so much on banks, but on many nonbank financial institutions, such as investment banks—many of which over the years operated like banks but without the regulation and protections banks received. Standard bank deposit insurance just did not cover the needs.

Providing liquidity to the relevant institutions to enable them to meet creditor demands required the use of monetary policy on a massive scale and often in new ways.

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Fortunately, massive and often innovative monetary policy was undertaken. But it was not enough to avoid a large drying up of credit and a sharp decline in demand and activity. Fiscal policy, in the form of large increases in public spending, was used to offset declining private demand. But government debt levels rose quickly and policymakers and investors became worried. Perceived sovereign risk the possibility that a government will default on its debts , which, for advanced economies, had been close to zero before the crisis—increased in a number of countries, making it harder to use fiscal policy to sustain demand and at the same time creating risks in the balance sheets of creditors, such as banks, that held the sovereign debt.

So-called diabolical loops developed between public and private debt: As central banks tried to maintain economic activity by reducing the policy interest rate for example, the overnight federal funds rate in the United States , the zero lower bound was quickly reached, and we have been stuck there now for more than five years.

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Policymakers did not succeed in raising inflation expectations to enable them to further decrease effective real rates. The risk of deflation is still clearly present across the euro area, and in some euro countries it is a reality.

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The recent financial crisis has taught us to pay attention to dark corners, where the economy can malfunction badly. Until the global financial crisis, mainstream U.S. macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The IMF's chief economist Olivier Blanchard takes readers into the dark corners of the financial crisis in his latest article 'Where Danger Lurks'.

Deflation increases the real value of public and private debt, which in turn makes repayment more onerous and forces debtors to reduce spending, and that in turn decreases economic activity—another diabolical loop. In this environment, economic policy—especially monetary policy—has taken on an element of black magic.

Some policies, such as, for example, the recent shift by the European Central Bank ECB to charge banks a tiny amount for deposits they maintain at the ECB in other words, a very small negative interest rate will have, on paper, very small mechanical effects. The size of this psychological effect, however, is extremely hard to predict or control. The crisis has one obvious policy implication: Authorities should make it one of the major objectives of policy—macroeconomic, financial regulatory, or macroprudential—to stay further away from the dark corners.

We are still too close to those corners. The crisis itself led to large accumulations of debt, both public and private. For the time being, the diabolical loops have receded, but it would not take much of an adverse shock for them to reappear. For a long time to come, one of the priorities of macroeconomic policy will be to slowly but steadily return debt to less dangerous levels, to move away from the dark corners.

If the financial system had been less opaque, if capital ratios had been higher, there might still have been a housing bust in the United States in — But the effects would have been limited—a mild U.

Sunday, August 31, 2014

Can the financial system be made more transparent and more robust? The answer is a qualified yes. Authorities have required increases in bank capital ratios—an essential line of defense against financial system meltdown. But banks are only part of a complex network of financial institutions and markets, and risks are far from gone. The reality of financial regulation is that new rules open new avenues for regulatory arbitrage, as institutions find loopholes in regulations. That in turn forces authorities to institute new regulations in an ongoing cat-and-mouse game between a very adroit mouse and a less nimble cat.

Staying away from dark corners will require continuous effort, not one-shot regulation. Macroeconomic policy also has an essential role to play. If inflation and nominal interest rates had been, say, 2 percentage points higher before the crisis, central banks would have been able to decrease real interest rates by 2 more percentage points before hitting the zero lower bound on nominal interest rates.

These additional 2 percentage points are not negligible. Their effects would have been roughly equivalent to the effects of the unconventional monetary policies that central banks pursued when the zero bound was reached—purchasing private sector assets and long-term government bonds to lower long-term interest rates rather than using the standard technique of manipulating a short-term policy rate.

Harvard Professor Kenneth S. That would remove the zero bound constraint. Turning from policy to research, the message should be to let a hundred flowers bloom.

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Now that we are more aware of nonlinearities and the dangers they pose, we should explore them further theoretically and empirically—and in all sorts of models. This is happening already, and to judge from the flow of working papers since the beginning of the crisis, it is happening on a large scale. Finance and macroeconomics in particular are becoming much better integrated, which is very good news.

But this answer skirts a harder question: How should we modify our benchmark models—the so-called dynamic stochastic general equilibrium DSGE models that we use, for example, at the IMF to think about alternative scenarios and to quantify the effects of policy decisions? The easy and uncontroversial part of the answer is that the DSGE models should be expanded to better recognize the role of the financial system—and this is happening.

But should these models be able to describe how the economy behaves in the dark corners? Let me offer a pragmatic answer. If macroeconomic policy and financial regulation are set in such a way as to maintain a healthy distance from dark corners, then our models that portray normal times may still be largely appropriate. Another class of economic models, aimed at measuring systemic risk, can be used to give warning signals that we are getting too close to dark corners, and that steps must be taken to reduce risk and increase distance.

The crisis has been immensely painful. But one of its silver linings has been to jolt macroeconomics and macroeconomic policy. The main policy lesson is a simple one: Stay away from dark corners. Letters may be edited. Please send your letters to fanddletters imf.