Monday, April 21, 2008

Iraq war and subprime crisis

An excellent analysis of American woes is published by Martin Neil Baily (Brookings Institution) in the New York Times (April 20, 2008, Op-Ed Pages). He clearly shows that the war is not a significant factor in the economy’s poor recent performance and the impending recession. The high price of oil is largely the result of strong demand, notably from China and India, pressing against a limited supply, and of the sinking value of the dollar.

The domestic economic problems, on the other hand, are mostly homemade: the responsibilities are shared among borrowers, financial institutions, investment banks and hedge funds, and credit-rating agencies. The Fed and other regulators could have been more reactive starting in 2005 but should not be blamed for present low interest policies which go in the right direction in difficult circumstances.

The war did not contribute either to increase much budget deficits, and government borrowing should have increased interest rates, thus should actually have curbed the housing boom, and not fueled it.

Then, the availability of money from around the world did help finance the housing boom, but it could as well have been directed more to business investment and job creation, absent the mortgage mess.

Let us add that in any case the longest expansion in the recent American history was due to come to an end sooner or later. Maybe the financial crisis should be seen as a typical end-of-cycle phenomenon.

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