Interesting Economic Analysis

The same forgetfulness holds for recessions, says Eugene Fama of the University of Chicago. . . . The nature of recessions is important because of what may be the free-market economists’ most surprising contention: that the recession triggered the financial crisis, not the other way around. Fama argues that the recession started as early as 2007, with consumers starting to spend less, borrowers... [more]

The same forgetfulness holds for recessions, says Eugene Fama of the University of Chicago. . . . The nature of recessions is important because of what may be the free-market economists’ most surprising contention: that the recession triggered the financial crisis, not the other way around. Fama argues that the recession started as early as 2007, with consumers starting to spend less, borrowers falling delinquent on their loans, and homeowners who lacked a vested interest in their houses beginning to walk away from their mortgages. So the complex financial derivatives at the heart of the financial meltdown were not its cause but its victims. “For 25 years, before the current recession,” Fama points out, “the derivatives worked well in lowering the cost of capital.” What has Fama learned from the crisis, then? “I learned a lot about government overreactions but not much about recessions,” he tells me. Confronted with a sharp economic downturn, governments face political pressure to act; stimulus spending and other state interventions seem sensible, even when the history of past crises suggests otherwise. Worse, the new public debt and regulations then hobble economic recovery. Rebounding from the post-2007 recession would have been quicker, Fama believes, if the government had mostly let free markets clean up the mess, reestablish true prices, and select the enterprises able to survive. . . . As in the 1930s and 1970s, so today: crises are a serious problem, but misguided economic policy makes them worse. After the 1930s, only war production could overcome the negative economic consequences of the New Deal. After the stagflation of the 1970s, it took the bold leadership of Margaret Thatcher and Ronald Reagan to reorient the West toward free markets and prosperity. How long will it take this time before governments understand that overreacting to the crisis and imposing disproved Keynesian remedies will dampen and delay economic recovery? - http://city-journal.org/2010/20_3_free-marketeers.html [less]