Raghuram Rajan was one of the few economists who warned of the global financial crisis before it hit. Now, as the world struggles to recover, it's tempting to blame what happened on just a few greedy ...bankers who took irrational risks and left the rest of us to foot the bill. InFault Lines, Rajan argues that serious flaws in the economy are also to blame, and warns that a potentially more devastating crisis awaits us if they aren't fixed.
Rajan shows how the individual choices that collectively brought about the economic meltdown--made by bankers, government officials, and ordinary homeowners--were rational responses to a flawed global financial order in which the incentives to take on risk are incredibly out of step with the dangers those risks pose. He traces the deepening fault lines in a world overly dependent on the indebted American consumer to power global economic growth and stave off global downturns. He exposes a system where America's growing inequality and thin social safety net create tremendous political pressure to encourage easy credit and keep job creation robust, no matter what the consequences to the economy's long-term health; and where the U.S. financial sector, with its skewed incentives, is the critical but unstable link between an overstimulated America and an underconsuming world.
InFault Lines, Rajan demonstrates how unequal access to education and health care in the United States puts us all in deeper financial peril, even as the economic choices of countries like Germany, Japan, and China place an undue burden on America to get its policies right. He outlines the hard choices we need to make to ensure a more stable world economy and restore lasting prosperity.
We examine the effects of aid on growth in cross-sectional and panel data--after correcting for the possible bias that poorer (or stronger) growth may draw aid contributions to recipient countries. ...Even after this correction, we find little robust evidence of a positive (or negative) relationship between aid inflows into a country and its economic growth. We also find no evidence that aid works better in better policy or geographical environments, or that certain forms of aid work better than others. Our findings suggest that for aid to be effective in the future, the aid apparatus will have to be rethought.
Aid, Dutch disease, and manufacturing growth Rajan, Raghuram G.; Subramanian, Arvind
Journal of development economics,
2011, 2011-1-00, 20110101, Volume:
94, Issue:
1
Journal Article
Peer reviewed
Open access
We examine the effects of aid on the growth of manufacturing, using a methodology that exploits the variation within countries and across manufacturing sectors, and corrects for possible reverse ...causality. We find that aid inflows have systematic adverse effects on a country's competitiveness, as reflected in the lower relative growth rate of exportable industries. We provide some evidence suggesting that the channel for these effects is the real exchange rate appreciation caused by aid inflows. We conjecture that this may explain, in part, why it is hard to find robust evidence that foreign aid helps countries grow.
ABSTRACT
The average distance of U.S. banks from their small corporate borrowers increased before the global financial crisis, especially for banks in competitive counties. Small distant loans are ...harder to make, so loan quality deteriorated. Surprisingly, such lending intensified as the Fed raised interest rates from 2004. Why? We show that banks' responses to higher rates led bank deposits to shift into competitive counties. Short‐horizon bank management recycled these inflows into risky loans to distant uncompetitive counties. Thus, rate hikes, competition, and managerial short‐termism explain why inflows “burned a hole” in banks' pockets and, more generally, increased risky lending.
Is there any need to clean up a banking system by closing some banks and forcing others to sell assets if the risk of a crisis becomes high? Impaired banks that may be forced to sell illiquid assets ...in the future have private incentives to hold, rather than sell, those assets Anticipating a potential fire sale, liquid buyers expect high returns, reducing their incentive to lend. Privately optimal trading decisions therefore lead to a worse fire sale and a larger drop in lending than is necessary. We discuss alternative ways of cleaning up the system and the associated costs and benefits.
ABSTRACT
To produce significant net present value, an entrepreneur has to differentiate her enterprise from the ordinary. To take collaborators with her, she needs to have substantial ownership, and ...thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain control rights that will allow them to be repaid. A vibrant stock market helps the entrepreneur commit to these two transformations. The nature of firms and financing are intimately linked.
Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may not want to stand by and watch banks collapse. However, ...unconstrained direct bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained central bank intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks should raise rates in normal times to offset distortions from reducing rates in adverse times.
What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite ...answers to these questions, it is certainly time to offer informed conjectures, and these are the focus of this paper.
We employ a novel data set on almost 30,000 trade credit contracts to describe the broad characteristics of the parties that contract together and the key terms of these contracts. Whereas prior work ...has typically used information on only one side of the buyer-seller transaction, we utilize information on both, allowing for the first analysis of buyer-seller pairs. An equally important distinction is that we have multiple contracts for the same buyer or supplier firms, rather than a firm-average response, allowing for the correction of time-invariant firm characteristics that might determine the choice of credit terms. We find that the largest and most creditworthy buyers receive contracts with the longest maturities from smaller suppliers, and that discounts for early payment tend to be offered to riskier buyers.
Does credit availability exacerbate asset price inflation? Are there long-run consequences? During the farm land price boom and bust before the Great Depression, we find that credit availability ...directly inflated land prices. Credit also amplified the relationship between positive fundamentals and land prices, leading to greater indebtedness. When fundamentals soured, areas with higher credit availability suffered a greater fall in land prices and had more bank failures. Land prices and credit availability also remained disproportionately low for decades in these areas, suggesting that leverage might render temporary credit-induced booms and busts persistent. We draw lessons for regulatory policy.
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