Sunday, May 24, 2009

What do we call this crisis?

I have been at a loss of determining what to call the global crisis. It does not seem like a recession but it is not a great depression. Is it just the crisis of 2008? Or is it the bank crisis of 2007-2008? After reading excepts from Richard Posner's A Failure of Capitalism. I believe he has a good concise definition.

Posner argues that this is a depression although not a great one. He states that the typical postwar recession is a partly self-correcting disinflationary contraction that subsides often leaving the economy healthier. The present downturn is a self-sustaining deflationary contraction whose costly aftereffects will linger. A typical recession is a market correction to some economic imbalance. A depression is a market failure. Market failure takes massive intervention by the government through fiscal and monetary policy along with regulation to potentially correct the failure.

We had a combination of imbalances from housing to global savings which were coupled with excessive monetary easing and a lack of government oversight. However the oversight problem is more complex than a lack of rules and restrictions on banks and finance. As Niall Ferguson argues in the NYT "Diminished Returns: Why we never learn the right lessons from financial crisis ", we have not learned any lessons from financial regulatory history. We started deregulation in the early 1980's for banks with significant success. The economic failure of inflation and poor growth the 1970's was a result of too much regulation.

If we are facing a depression of market failure, what will we have to do to correct it. The same regulators and legislators who got us into this mess are now the one who are supposed to solve the problem. The market failure of seeing signs of a problem through some early warning system or providing potential solutions may that will not stifle future growth are real and should not be discounted. As Ferguson states at the end of his article, Quis custodiet ipsos custodes? Who regulates the regulators?

However going forward, I will refer to the current economic problem as the Depression of 2008.

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