As if core Europe did not have enough problems of its own, a new threat has arisen – collapse of the European periphery. The deteriorating foreign exchange and financial conditions of satellite countries in the euro area – from the Baltic region to Eastern Europe, Turkey and Ukraine, not to mention the imploded Icelandic financial system – add yet another source of uncertainty.
As the real economy sinks quickly into a deep recession, governments are groping for measures to limit the downturn. And as interest rates are quickly bumping against the zero bound, an aggressive use of fiscal policy seems to be the only way to sustain demand. Fiscal policy seems particularly appropriate since our macroeconomic models tell us that fiscal policy multipliers increase when more economic agents become liquidity constrained because they are then likely to spend any additional income they receive.
Europe’s new crisis plan will hopefully stop the panic. This column explores the remaining issues – the sharing the burden of transnational bank losses and restarting the inter-bank lending market. It suggests a technical change to the guarantees that would produce a better result.
This is a once-in-a-lifetime crisis. Trust among financial institutions is disappearing; fear may spread. Last week’s US experience showed that saving one bank at a time won’t work. A systemic response is needed and in Europe this means an EU-led initiative to recapitalise the banking sector. Unless European leaders immediately unite to address this crisis […]
Europe’s universal banks were supposed to be immune to the fallout from the sub prime crisis. But we are now discovering that any financial institution is vulnerable if its leverage is too high. The key issue for Europe is not only that its largest banks are vulnerable because they have high leverage, but that they […]
A key issue for the $700 billion bail out plan now being finalized is the pricing of the ‘toxic assets’ the US Treasury should buy. The main target of the Paulson plan is the market for securities based on low quality mortgages (sub prime and ‘Alt A’ mortgages). This subclass of the general universe of […]
The US financial system is being nationalised. The piecemeal approach followed so far had clearly not been working. Hence the US political system is working overtime to reach a bipartisan agreement on a systemic solution. The centrepiece is already known: the US government is going to buy $700bn (€480bn, £380bn) of the so-called “toxic” assets. […]
The official mantra after the No in Ireland seems to become “let us continue with the ratification process”. This is a high risk strategy since Ireland’s veto power will continue even if all other 26 ratify. The Irish electorate will know this and thus have little reason or incentive to vote differently at second referendum. […]
With the outbreak of the so called ‘sub prime’ crisis the attention of policy makers has been focused on the US housing market. It is by now common knowledge that the problem started with a bubble in US house prices. However, it is not widely appreciated that in Europe housing prices have also increased over […]