Ten years after the world economy teetered on the edge of financial collapse, are we headed toward another financial crisis?
At sold-out Economic Outlook 2018 events in New York and Chicago in January, leading Chicago Booth economists addressed this pressing question and other critical issues facing the global economy. The events took place shortly before the Dow plunged nearly 1,600 points in a single day—the largest one-day point drop in history.
Evaluating emerging trends and potential trouble spots, economic luminaries from Booth shared their insights into the economic outlook for Wall Street and Main Street—ten years after the financial crisis.
Is the Past Prologue?
There are few obvious signs of financial stress at the moment. Stock indexes are up, and corporate profits and cash continue to accumulate from a private sector–friendly tax law. Interest rates and inflation remain relatively low.
Yet a decade after the credit and stock crash of 2008, the Booth experts convened in Chicago sounded notes of caution. “I never say never about anything, given what I experienced in 2006 through 2009,” said Randall S. Kroszner, Norman R. Bobins Professor of Economics, when asked if we’re headed toward another financial crisis. Kroszner—who served as a governor of the Federal Reserve System from 2006 until 2009, in the midst of the Great Recession—added: “I'm worried when people aren't worried.” Indeed, volatility spiked and the Dow took its historic plunge just weeks later.
“The danger areas continue to be worries about China, where there has been a big acceleration of debt, and a nagging feeling that we really don’t know what’s in the European financial institutions,” said Austan D. Goolsbee, Robert P. Gwinn Professor of Economics and the former chairman of the Council of Economic Advisers, where he served as a top economic adviser to President Obama. “That said, the overall growth around the world is looking a little better, for the first time in a little while.”
During the Economic Outlook event in New York, the trauma of the 2008 crisis seemed in the distant past. Kroszner and Erik Hurst, V. Duane Rath Professor of Economics, both said they anticipate strong growth this year, and neither believe there to be a threat of inflation or recession on the immediate horizon.
Kroszner sounded particularly optimistic. “I do think [the tax cut] is going to have a positive impact, both in the short run and the long run,” he said. “I think the broad direction is fairly clear: cutting personal tax rates on a weighted average, of about three percent or so, will have positive impact on demand, because that's going to allow for higher disposable income in the short run.”
While also believing the tax cuts would boost GDP in 2018, Hurst cautioned that the benefits of the tax cut might not spread to the middle class. The tax cuts should “help stimulate demand,” said Hurst, a macroeconomist whose work focuses on housing markets, labor markets, and household financial behavior. However, he didn’t expect the cuts to improve productivity growth, which drives wages and—along with population growth—GDP. “It’s going to have a big effect on inequality, both in the short and long run,” he said. “It’s centered on a tax cut for the top of the distribution, more so than the middle of the distribution.”
Interconnection, Bubbles, and Seeing the Fault Lines
The 2008 crisis, fueled by overleveraged banks, “nonbanks,” and indebted consumers, surprised many regulators, who bolted into action in late 2008 and early 2009 to put the brakes on a global depression.
“It was very hard to see the fault lines,” observed Kroszner in Chicago, when asked if we are headed toward another financial crisis. Just before the crash, he said the Fed was working on a project to get the Securities and Exchange Commission to share information, which didn’t go smoothly due to a “lack of trust” between the regulators.
Kroszner and his fellow Chicago Economic Outlook panelists stressed the importance of “interconnection”—regulators jointly monitoring important gauges of debt and cash levels—for preventing a future crisis.
Raghuram G. Rajan, Katherine Dusak Miller Distinguished Service Professor of Finance, expressed concern about the potential leverage and disappearance of liquidity. He also said he believes the likelihood of a credit bubble bursting is “a very legitimate question right now.” Rajan served as the governor of the Reserve Bank of India from 2013 to 2016.
Cryptocurrency, the China Wildcard, and the Danger of Low Interest Rates
Although asset prices have climbed dramatically, the Chicago panelists noted no clear indication of an imminent bubble on the scale of the dot-com or housing bubbles.
They did raise concerns about high levels of debt, particularly in China. The panelists agreed with Goolsbee that current economic indicators are generally positive for global growth; on the other hand, Goolsbee was less sanguine about possible wildcards, such as a trade war with China or the threat that the country will stop buying US Treasury debt.
The discussion in Chicago touched upon the growing, highly volatile trading of cryptocurrencies, their risks, and where the crypto industry may be headed. “This is what [JPMorgan Chase chairman, CEO, and president] Jamie Dimon has been saying, and he’s right—that if it’s going to get big, there has to be central bank support,” noted Rajan on possible regulation of cryptocurrencies. Kroszner added that a lack of a “legal framework” for regulating virtual currencies poses a major problem. “If there's no legal framework, there's no recourse,” he said.
In New York, both Kroszner and Hurst saw the chances of a new recession—or financial crisis—as remote, at least for 2018. But they raised concerns about how the Fed will handle the next recession when it does arrive. With the federal funds rate currently less than what it was before the Great Recession began (it was 5.25 percent in 2007) they worried the Fed wouldn’t have enough ammunition to cut rates aggressively when the economy slows.
Still, Kroszner cautioned that the Fed should take care not to make the cure worse than the disease. “If you’re just raising rates willy-nilly, then you’re going to get the next recession,” he said.
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