Thursday, 2 September 2010
Be kind, rewind...
The term new normal is being has been used by PIMCO's manager Bill Gross to describe the new economic environment, it is misleading. What was normal before was in fact grossly abnormal and in fact utterly excessive.
125% LTV for Northern Rock's Together Mortgage? Was that normal? Was that sound lending?
The issue today is that politicians are trying to stimulate demand back to its past level, when excesses where legion. This is not sound and it is not the path to recovery.
Carmen Reinhart is a professor at the University of Maryland and Vincent Reinhart is resident scholar at the American Enterprise Institute. This is based on a paper presented at the Jackson Hole Symposium.
"Part of these changed prospects after a crisis simply reflects the correction of expectations. During episodes of financial euphoria – from the diving bell, through the steam engine and thereafter – the old rules seem not to apply. Lenders provide easy credit, investors bid up asset prices, and businesses invest unwisely. Spending advances rapidly, and debt builds up. Yet recent discussions about the “new normal” leave the misleading impression that the pre-crisis environment was “normal”.
A prudent post-crisis policy, therefore, must be alert to threats both to supply and demand, not demand alone. But the bigger worry remains the assumption that dust has begun to settle; that the shock from the crisis is temporary, when it is likely to be deep and persistent. Today, as in the past, over-optimistic fiscal authorities are over-estimating tax revenues. Financial supervisors want to believe that troubled banks are temporarily illiquid, not permanently insolvent. And central bankers like Mr Bernanke may soon attempt to restore employment to unattainably high levels. If they do so, the road to recovery will be long, and the lessons of history will have been ignored once more."