(I am an occasional contributor to roundtables of economists in the magazine The International Economy. The topic of this month’s roundtable was: Is a serious global debt crisis possible?)
As Hyman Minsky famously described, when market participants believe that crises are possible, they behave in ways that make the system relatively robust. Only when the chance of a crisis is deemed very low, or forgotten entirely, do financial markets accept the degree of leverage and illiquid commitments that make a crisis possible.
This means, among other things, that crises are inherently difficult if not impossible to predict. A predicted crisis is a crisis that does not occur.
So to the question of whether a serious crisis is likely in the near future, the sensible answers range from “maybe” to “I don’t know.”
There are other questions we have a better chance of answering. First, are the authorities able to handle a crisis if one does occur? And second, what kind of spillovers will a financial crisis have for the rest of the economy?
On both questions, the answers would seem to be reasonably encouraging for the rich countries, less so for the developing world.
The 2007-2009 financial crisis and the 2020 pandemic were very different events in many ways. But one thing they had in common, is that both demonstrated the awesome power of a committed central bank to overcome almost any kind of disruption to the financial system. The Fed, in particular, was willing to buy a much wider range of assets, and intervene in a wider range of markets, than almost anyone would have previously predicted. Today there can be little doubt that the Fed can stem the contagion from even the biggest bank failure or sovereign default, if it wishes to.
That last caveat is worth emphasizing. The decade after 2007 saw a sharp divergence between the US and Europe. While the Fed moved aggressively to repair the financial system, the ECB moved more slowly — in part because of tighter institutional constraints, but also, it’s now clear, because decision makers at the ECB saw the crisis as a chance to push through a broader set of policy changes. Not only Greece but also Spain, Italy and Ireland were in effect held hostage by the ECB, which refused to restore liquidity to their banking systems until they accepted various structural reforms.
This divergence suggests that, in the rich countries, the question may be less what central banks are able to do in response to a banking crisis, and more what they are willing to do.
As for the second question, it’s worth maintaining a bit of skepticism that finance is as important to the rest of us as it appears in its own eyes. In retrospect, it seems clear that the long-term damage to the US economy after the 2007 crash had more to do with the collapse of housing market — a pillar of the real economy — than with the the financial aftershocks that got so much attention at the time. When we think about the dangers of a financial crisis today, we should ask not only what are the chances of bank failures and asset market disruptions, but how important those markets are for real activity. Mortgages and cryptocurrencies are very different in this respect.
For the developing world, unfortunately, such a relatively sanguine view is harder to sustain. Central banks are much less powerful in countries where a large fraction of domestic obligations involve foreign currencies, and where financial conditions are largely determined beyond the borders. Serious spillovers to the real economy are more likely in this case. If there is a crisis in the near future, it may finally teach the lesson that the world has been slowly learning: Outside the core of the world economy, an essential requirement for any kind of macroeconomic management is a degree of financial delinking.