4 Factors that Make the Global Economy More Sensitive to Future Crises

I liked this piece by Philippe Bacchetta and Eric van Wincoop at VOX regarding the causes of the global great recession.   In it, they discuss the factors that led to the crisis and why it was so globally widespread.  This section, in particular, jumped out at me:

“There were also several factors that made the global economy more sensitive to a global panic:

• First, credit was tighter due to the financial crisis, making firms more vulnerable when hit with lower demand and lower profits.
• Second, there was limited scope for monetary policy as interest rates were already approaching the zero lower bound.
• Third, there were constraints on countercyclical fiscal policy due to increasing debt levels and new fiscal rules.
• Fourth, economic integration, although incomplete, had substantially increased in previous decades.

The first three factors generate vulnerability to a self-fulfilling panic in general, while the last one generates particular vulnerability to a panic that is global in nature.”

The interesting thing is that none of these factors have actually gone away.  In fact, you could argue they they are all major constraints going forward.  The private sector, although de-leveraging, is much more leveraged at present than it was in the early 2000’s when the seeds of the crisis were sowed.  Second, central banks are already at the zero lower bound and have been for years.  The arsenal to combat future problems is limited at present.  Third, global debt to GDP has risen substantially in the last decade and remains a major political constraint with regards to expansion of future fiscal policy.  And lastly, the global economy is only becoming more and more interconnected.  And that means that a crisis in one country is much more likely to influence the global economy.

Although we’ve slipped out of the great recession one could easily argue that we’re more vulnerable to future crises than ever.