Sunday, January 25, 2009

It Was the Saving Glut?

An increasing number of observers are placing the origins of the current economic crisis with the saving glut explanation of global economic imbalances. This trend was noted (and more-or-less endorsed) by The Economist this week and mentioned by Menzie Chinn in this post. It is worth noting some prominent observers such as John Taylor and Stephen Roach dismiss the notion of a saving glut entirely and instead pin the blame on bad policies. My own view is that both bad policies--specifically loose monetary policy--and a saving glut played a part. Here is what I said over at Econbrowser on the role played by policy:
What the about Fed's low interest rates in early-to-mid 200s? Surely there was something exogenous here in that no one expected the interest rates to drop as low and long as they did during this time. Not only did the Fed's unexpected loose monetary policy affect domestic consumption/savings, but it got exported to the dollar block countries and to some extent to non-dollar block countries (e.g. ECB had to keep watchful eye on dollar lest the Euro got too expensive). I am not saying it was the only enabler, but it certainly seems important...
I further develop this point--and provide some evidence--in this article (see page 374). However, as noted by Brad Sester, the expansionary policy story for the rising current account deficit best fits the data for the period 2002-2004 while the traditional saving glut story does a better job thereafter. Of course there were other factors at work during this time--the securitization of finance, underestimating aggregate risk, the lowering of lending standards--but the low interest rate environment generated by these two forces was a key contributor to the current economic crisis.

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