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16. December 2010Perspectives on Financial Crises

Perspectives on Financial CrisesDiscussion of Prof. Peter DiamondGernot Doppelhofer

Discussion

1.Labor Markets and Recovery

2.Debt and Crises

3.Bubbles

4.Banking

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Labor Markets and Recovery• Is the ongoing recovery in the US different from previous

recoveries?

• How can policymakers improve recovery in labor markets?– recent US policies: extension of Bush tax cuts, extension of

unemployment benefits– how to deal with mismatch and structural problems?

• Risk of rising unemployment in European countries– UK: unemployment rate 7.9% (Oct 2010), employment rate from

16 to 64 age group 70.6%– Peripheral euro countries: structural reform and fiscal

consolidation implying weak recoveries– Germany: strong export-led growth sustainable? Stronger

domestic demand.

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Debt and Crises

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• Bond market awakening– increase in 10 year bond yields in US, Germany, UK over last month– real rates vs. inflationary expectations– widening spreads in euro countries between highly indebted

countries and German bonds

• How to deal with unsustainable sovereign debt levels?– “ordered” restructuring vs. bailout of euro member countries– consolidation of structural debt: pension– government spending and tax reform

• How to deal with contagion– EU wide coordination?– ECB intervention

Bubbles

• recurrent nature of boom and busts (Reingard & Rogoff)– rapid expansion of credit: US subprime, Irish and Icelandic Banks– ”this time is different”– incentive for excessive risk taking: private gains, social losses– lack of supervision or regulation

• Policy issues– ”leaning against the wind” during ”good times” vs. ”cleaning up” after

crisis – increasingly globalized and integrated financial markets and

institutions– who is responsible/accountable: national vs. international policies?– more bubbles in emerging markets due to loose monetary policy

(China)

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Banking• Banks at the center of ongoing credit and debt crises

• Deleveraging and restructuring– illiquidity vs. insolvency– stress tests?– public support for illiquid (some insolvent) banks?– haircuts for bank share and bond holders

• Adequacy of existing system– capital requirements, accounting guidelines, Basel agreements– rating agencies and market discipline– conditional liquidity support

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Financial Crisis – what crisis?• Ongoing crises moderate impact on Norway

– Norway was “lucky” with timing of rebound of oil– Norwegian “Pension Fund” (NBIM) did well in crises

• Scandinavian countries learned some lessons from big financial crisis in early 1980s

– regulation and role of state– financial stability– do we have institutional framework in place to ensure

internal/external discipline

• Can we be complacent? No!• Some of themes also apply to Norway/Scandinavia

– efficiency of labor markets: skills mismatch, tight labor markets– tight housing markets (Oslo)

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