Wednesday, January 14, 2009

Fama on Bailouts

The blog world is indeed exploding. Even Fama and French have started writing a blog. At this rate, students can sit at home and get free tution. 

Fama has written an essay yesterday on Bailout and Stimulus Plans.  In this, he talks about the equation Private Investment = Personal Savings + Corporate Savings + Government Savings. This equation implies that fiscal bailouts end up displacing something else, so fiscal bailouts don't really end up helping much. 

The question that arises in my mind is - how is Central Reserve Bank printing money included in this equation? If population at large doesn't have a problem with Fed printing money, then US government savings might go up just by printing money. That implies that fiscal stimulus financed by printing money is great - as long as people don't have a problem with it. Now this doesn't sound right, so I must be missing something. 

Also, does this equation take into consideration the financial considerations that exist in real world? For e.g. if govt issues bonds today to finance spending, it sells the bond to some investor. The investor buys the bond in his bond portfolio. The riskiness of his bond portfolio goes down because it has larger proportion of  government securities. So he/she could lever it up just a bit more than is possible with a portfolio that has all private sector bonds. This creates lending capacity in the system, which could be given to private sector borrowers. So, while government borrowing displaces private sector borrowing, is the ratio 1:1? Does Savings = Investment really hold at all times, or is there a timing mismatch? 

This is all getting a bit confusing. 

This is an excellent article by some Aussie Prof: Bernanke an expert on the Great Depression?


Econlogic said...

Right now the government is not displacing anything. Crowding out is the most faulty logic that can be applied to the current cyclical reality. Personal saving in the US is climbing fast and private investment spending set to collapse. Government dis-saving is a must to boost global effective demand.


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