Finance and Insurance: Powerful Economic Forces Pt 8

Then, I want to move to futures markets and forward markets. A forward contract is a contract made between two parties for execution in the future. Generally, these are called over-the-counter contracts because they’re not arranged through exchanges. We also have standardized contracts that are traded on exchanges and they’re called futures contracts.

The futures contracts were invented in Japan in the 1600s at Osaka and they were developed for the rice market in Japan. They were uniquely Japanese until pretty much the nineteenth century and then they were copied all over the world and are now very important.

I’m going to talk about one futures market that I have been instrumental in developing. I’ve been working with the Chicago Mercantile Exchange to create a futures market for single-family homes, which is sort of my connection to the futures industry. Of course, there are many futures markets that we’ll talk about. They’re very interesting to me and I wonder why the business community isn’t more aware of them. A futures market has a prediction going out years into the future of what every financial variable will be doing, so you can see the future in a sense through the futures prices. It’s not always correct to think of it that way. We have to get into the theory of futures markets. In many cases, that is not the right way to think about futures prices, but there are very important futures markets that – In the next lecture, I want to talk about the various kinds of futures markets that matter.

We have a stock index futures market and notably we have an oil futures market. The oils futures market is very significant because it represents the price of energy on dates into the future. We can now see the price of oil going out years into the future. We’ve just hit $100 barrel price of oil, but what does that mean? Does that mean we’re going to live in a world with $100 oil? Well, not if you look at the futures market, which is in backwardation now and it’s predicting major drops in the price of oil.

Then, I want to talk about options markets. This is getting close to the end of the course. An option is the right to buy something. Typically, we think of it as a stock option. An option is a contract that says you can buy so many shares of a company. The options have been traded for several decades starting with the Chicago Board Options Exchange. But, now there are many options exchanges. We have prices of options that change minute by minute. Now, what do these changes and these prices mean? The options are a very useful technology for managing risks and I think that we’ll see a rapid over the next few decades, we’ll see rapid expansion in the scope of options contracts traded on the exchanges.

Finally, for the last lecture for this semester, I want to pull this together and talk about one of the themes that, is summarized in terms of a theme of this course, which is the democratization of finance. Finance used to be a very esoteric field that only a few people in London and Paris and other world centers understood – Amsterdam and other places where financial technology emerged, but it’s becoming democratized. With each year that goes by, the concepts of finance are being applied more broadly and involving more and more people. With electronic technology, it’s becoming more economical to offer sophisticated financial services to everyone. This is something that we’re seeing. I think the subprime crisis that is the current financial crisis highlights this very well. What does subprime mean? Well, I think it stands for the general population. The subprime mortgage market was bringing people into the mortgage market who in prior decades would not have been involved, would not have had any mortgage.

The problem, of course, with the democratization of finance is that if you raise the participation in financial markets, then you bring in people who are less and less knowledgeable, less and less understanding of concepts of finance and less capable and more vulnerable to exploitation. So, the democratization of finance is, I think, the ultimate mission that I find central to this course, but it brings with it dangerous and hazards and we have to think very carefully about how we do it.

Finance and Insurance: Powerful Economic Forces Pt 8

Finance and Insurance: Powerful Economic Forces Pt 7

There’s also a question of psychology. The following lecture will be about banking and about the supply of money and the money multiplier. It’s also about how banks operate, what their functions is in our society and why they are such important institutions that have gone back for hundreds of years and remain powerful, central features in our economy. It’s also about bank regulation, such as the Basel Accord, Basel I and Basel II. I also want to talk about the impact of information and technology on banking.

 

The following lecture is about monetary policy. What do central banks do? In the United States, the central bank is called the Federal Reserve. In the United Kingdom, it’s the Bank of England. In Japan, it’s the bank of Japan. And in Europe, it’s the European Central Bank. All of these banks are really in control of short-term interest rates and these interest rates are used to try to manage and stabilize the economy. In response to the subprime crisis that we are now in, our central bank, the Federal Reserve, has been cutting interest rates aggressively to try to save the economy that appears to be declining. I want to try to understand in that lecture, help us to understand how this works and how we’re getting solutions, possible solutions to these problems.

 

Then, I want to talk about investment banking. An investment bank is a different kind of bank. I was talking up to this point about commercial banks. An investment bank is not a bank that accepts deposits. It doesn’t deal with the general public. Instead, it deals with financial institutions and it gets involved in underwriting securities for financial institutions. It’s a very important industry and it’s also one in which any of our students have found jobs, so I think it’s important for us to try to understand the history of investment banks, the role they have in our financial community and how they’re regulated.

 

Then, I want to talk about money managers, professional money managers, people like David Swensen, This is a community of people in a different segment of the financial industry. These are people who manage portfolios. We want to think about what kinds of forces operate on them and what kind of – I’m interested in viewing them partly as people who are very experts in a certain kind of technology who live in a very competitive environment and try to understand why some of them succeed much more than others. It also relates to behavioral finance. That is, ultimately they are human beings like anyone else and some of their difference in success or failure may have to do with their own interconnections and their own psychology and interpersonal psychology.

 

Then, I want to talk about brokerage. Those are institutions that arrange for or manage the buying and selling of financial assets such as the New York Stock Exchange. Now, the brokerage industry – the New York Stock Exchange goes back into the eighteenth century. It’s very old. In fact, the idea of the stock exchange goes back to the fourteenth century when in Flanders, the first stock exchange called The Bourse was established. So, it goes back many hundreds of years, but it’s in rapid change now because of information technology. It’s one of the most rapidly changing, hard to keep up with areas because someone can set up an electronic exchange overnight and suddenly become a base for trading trillions of dollars securities. It fits in well with the theme of this course about technology because in understanding what’s happening with brokerages, our technology, the new information technology, is central.

Finance and Insurance: Powerful Economic Forces Pt 7

Finance and Insurance: Powerful Economic Forces Pt 6

We’ve had episodes in our history when real interest rates have made major moves and these movements are very important for what is happening in our lives.

Most recently, a few years ago, we were living in a regime of negative real interest rates when the Fed was pursuing a very aggressive monetary policy. I suspect that with the subprime crisis, the Fed will be pushing real interest rates down dramatically again and we may be again in a period of negative real interest rates again.

 

After that, I want to talk about the stock market. There’s a lot to talk about. Of course, stocks are shares in companies and they’re traded on stock exchanges and they’re interesting to analyze because there’s sort of an ambiguity about stocks that is not widely perceived by a lot of people. That is, share repurchase can change the units of measurement in a security and companies have to decide how leveraged the stock will be, which changes the stock price. Leverage, meaning how much debt the company takes on. Moreover, companies have to decide how much dividends to pay on the stock. That’s a decision of the management of the company and we have to understand how they make that decision and what does that mean to people who are valuing stocks. It’s a very simple idea. The idea of dividing a company up into shares and selling them off, but in practice, it involves a lot of complexities.

 

We’ll be talking about the Modigliani-Miller Theorem and related issues in this lecture as well as something about the behavior of the stock market and its tendency to go through dramatic movements. For example, like it has done recently if you’ve been following it earlier this year.

 

The next lecture will be about real estate and that brings us into the subprime crisis and connects with interests that are central to my own thinking. The housing market is a huge market. Right now, the total value of single-family homes in the United States is about two trillion dollars and the market has been becoming increasingly speculative. Home prices have gotten unstable. Nationally, home prices in the United States rose 85% between 1997 and 2006 in real terms, in inflation-corrected terms. We’ve seen almost a doubling in the price of the average home in the United States.

Why did that happen? Now, they are falling and in real terms, home prices have fallen almost 10% since the peak in 2006. This is not just a U.S. phenomenon, many countries around the world are experiencing home price booms and the beginning of what might be a home price bust. I want to consider the market for homes and the market for mortgages, which are the instruments that finance homes. To what extent was the housing boom that we saw in recent years, the result of revolution in financial technology? There has been a lot of changes in our mortgage institutions that might be part of the reason for the boom in home prices.

Finance and Insurance: Powerful Economic Forces Pt 6

Finance and Insurance: Powerful Economic Forces Pt 5

Certain kinds of financial markets called Prediction Markets, which may, for example, predict the outcome of an election has been seen to be very accurate predictors, often better than pollsters can manage. So, there seems to be some deep wisdom of the market. I think that Efficient Markets is an important concept.

 

On the other hand, and this is something that I want to emphasize. You don’t want to carry that too far and one of the lessons of behavioral finance is that markets are not really efficient in a global sense. Human psychology drives markets a great deal. If markets were perfectly efficient, David Swensen could not have done what he did. It would not be possible to make excess returns in finance. I believe it’s clear that it is and that people who do so are people who understand more than the core efficient markets theory. They understand something about human nature and how human nature interacts with our institutions.

 

The next lecture is about behavioral finance and I want to talk in that lecture about research and psychology, things that come out of another department here, the psychology department, which has traditionally been ignored in economics and finance but it is coming back.

 

I want to talk about Kahneman and Tversky’s Prospect Theory which is a very important and this would be a little technical. Psychologists can become mathematical and technical as well. It’ll be an important part of our understanding of financial markets.

 

Then, I want to talk in the next lecture about regulation and that means government oversight of financial markets and not just government oversight, there are also the so-called self-regulatory organizations that are created in the financial industry to self regulate. So, for example, FINRA, which used to be called the National Association for Security Dealers, is a membership organization of people in the financial community and it imposes rules on its members. It’s not a government organization, but it is a regulator. The problem is that not everyone is nice and not everyone is high-minded. So, the success of financial markets is, in many ways, a success of regulations. Governments establish regulators who set down rules for participants in financial markets and these rules may be perceived as onerous and costly to people in the financial community, but ultimately it’s their salvation and it’s what makes everything possible.

 

After that, I want to talk about the debt markets. Debt is the simplest of financial instruments. It consists of a promise to pay, usually denominated in currency, and there are both long-term and short-term debt instruments. The shortest term debt instrument in the United States is the Federal Funds Rate, which is an overnight rate, one day maturity, and the longest issued by the Government thirty-year government bond, which will be repaid three decades in the future. There have also been one hundred-year bonds and there have also been perpetuities that in the U.K., for example, the British Consoles, have no expiration date and they have infinite maturity.

So, the debt market is something worthy of studying because it really represents a market for time itself. What is it that we’re talking about when we talk about the rate of interest? It has units of time, it represents the price of time and it is something that fluctuates through time as well in interesting patterns. They are very important drivers of our economy and our lives. The theory of the term structure is the theory of how interest rates differ according to maturity or term. There are not only debt instruments that are payable in currency, but there are also indexed debt instruments that are indexed to the price level and so they give real interest rates.

Finance and Insurance: Powerful Economic Forces Pt 5

Finance and Insurance: Powerful Economic Forces Pt 4

One thing we have to understand in understanding the progress of financial technology is its fundamental relation to information technology. Computers, the Internet and communication devices are fundamental to financial progress and they make things possible that wouldn’t have been possible before. Oftentimes, inventions that seem in the abstract to be good ideas impossible because something that you have to do to make it actually come into practice is too expensive and so it’s not economic to produce the invention.

But then, developments in other fields can change the relative prices and suddenly make an idea that had been hypothetical and unapplied suddenly work well. So, financial inventions also involve experimentation. Like in any other invention, nobody knows what will work and abstract theory doesn’t guide you completely. Once an invention is seen to work, it is rapidly copied around the world.

 

We can see various breaks in financial history when some new idea was suddenly proven workable. Traditionally, financial inventions were not granted patent rights, but now in the United States and in a number of other countries it has become possible to patent financial inventions. I know I’ve done that in my life and so I think it gives a different perspective on finance.

 

Then, I want to talk about insurance. The institution of insurance is something that really came in. It’s one of the earliest – I consider it a division of finance – really came in the 1600s when probability theory was invented. The mathematical theory of probability was unknown until that time and you can see that insurance suddenly made an appearance at that time. This will be a historical as well as a theoretical discussion of insurance.

 

Then, I will move to portfolio diversification and supporting financial institutions. This is again, a more theoretical lecture. It will be about the capital asset pricing model. It will be about the securities market line, about the data, about the mutual fund theorem and it will also be about institutions that we have, about investment companies and their management. So, it’s really parallel to an insurance discussion. Insurance pools risks like life risks or fire risks by writing policies to individual policyholders. Portfolio management pools risks in a different way by assembling a diversified portfolio or a portfolio that’s negatively correlated with a risk that someone has.

 

Then, I want to go to the efficient markets theory. Efficient Markets is a theory about, well, it came in about three decades ago, maybe it’s closer to four decades ago, it’s a theory that financial markets work very well and incorporate information very well. The efficient markets hypothesis was encouraged. Actually, the idea goes back over 100 years. It’s encouraged by the observation that financial markets seem to respond with great speed to new information and, when new information appears, prices will suddenly adjust in the financial markets.

Finance and Insurance: Powerful Economic Forces Pt 4

Finance and Insurance: Powerful Economic Forces Pt 3

I think in the remaining time, I will just go through an outline of the course and that means go through the topics of the various lectures and then I’ll let you go for today.

 

So, the way this course is divided up is different than the Financial Theory course. If you look at John Geanakoplos’s course on Financial Theory, his mathematical concepts are central to his outline of the course, but this being a Financial Markets course, I’m dividing it up more in terms of markets and institutions. I still want to start with some theory and I thought that, well, I plan to start by talking about the most basic concepts of risk management, which underlie finance. That will be Wednesday’s lecture. I call it the universal principle of risk management pooling and the hedging of risk. I think it’s the most important theoretical concept that underlies finance and insurance, which we’ll also talk about a little bit in this course. The idea is that if you spread risks, they don’t disappear, they’re still there, but they’re spread out over many people and the impact on any one person is reduced.

 

So, a basic principle of insurance is that if each person or each family suffers the risk, for example, that a parent, father or mother might die which is a terrible blow to the family, but it’s not a blow to society as a whole because people die and it has a certain statistical regularity. So, it makes sense that we pay families who have lost a father or a mother so that they can keep going. It benefits everyone to have a situation in place for that. I wanted to talk about that with a little bit of reference to probability theory and so that’s what I will be covering.

 

The next lecture will be among the more mathematical, although it’s very elementary. If you had a course in probability and statistics, then you’ll find it easy to follow, but it’s self-contained again. I feel like I have to introduce concepts like variance and co-variance and correlation in order to talk about finance. So, that’s what we’ll do in Lecture Two.

 

The following lecture – I want to come back to some basic themes that – the third lecture about technology and it relates to another book that I wrote. I’m not assigning it, but I wrote a book called New Financial Order in 2003 about technology and finance. A theme of that book was that – I’ve already said this to you, but it’s very important point that financial technology is evolving and improving just the way engineering technology or biochemical technology is improving. It’s getting better year by year and the course of finance over your lifetime will be dramatic. So, the financial institutions that we have ten years from now will look very different from the ones we have now.

Finance and Insurance: Powerful Economic Forces Pt 3

Finance and Insurance: Powerful Economic Forces Pt 2

I’m bringing in outside speakers as part of this course and among them. I’m going to bring in people who I think have been philanthropists. That’s the mode of thinking that is most attractive when you think about financial markets. So, let me tell you about – I have slots now for four outside speakers. I’ve lined up two of them and let me tell you about the two that I’ve already lined up.

The first one is our own David Swensen. David Swensen came to Yale University in 1985 from Wall Street, although he was a Yale graduate. At that time, the Yale endowment was actually slightly under one billion dollars. What is the endowment of Yale? The endowment is defined as the financial assets that Yale University owns. Yale also has an art collection, which is worth many billions, but we don’t count that as part of the endowment because they will never sell it.

So, it doesn’t provide income for us. Yale also has a physical plant like this beautiful building that we’re in, but that’s not part of the endowment either. The financial assets that Yale had at that time were about a billion dollars. Since then, David Swensen has invested or has managed the investment of this endowment and it has done phenomenally well. Yale now has over twenty two billion dollars in its endowment. So, the return he got from 1996 to 2006 was 17% a year on investments. Last year, the return on the Yale portfolio was 28% in one year. Now, I don’t know how impressed you are, the year before that it was 22% in one year.

 

Now, some of this might be luck but I don’t think it’s all luck because he’s done this consistently for so many years. If you look up around this campus now, you’ll see a lot of constructions, a lot of things are being spruced up and improved. I think David Swensen has had a big hand in doing that because we have the money that makes it possible.

 

The endowment at Yale is something like two million dollars per student now, that’s just sitting there as money that could be spent. How did he do this? That’s one of the amazing things. It seems to have something to do, I think, with academic understanding that being part of a university community is a good thing for investing and you can see some evidence in that. Harvard University, Princeton University and other universities have done extremely well on their endowments, however, not quite as well as Yale. Yale, I think, is number one performer. So, it’s very interesting that we’re able – it’s very significant that we’re able to get David Swensen. He doesn’t do a lot of public speaking but he is willing for young people like you to do this. So, that’s one of our outside speakers. He also has two books about investing that we’ll talk about.

 

The second person I have set up now to come, although the date on the syllabus online is going to be changed is Andrew Redleaf who is also a Yale graduate and who set up a hedge fund called Whitebox Advisors. It has done phenomenally well in investing. I think I have on the syllabus a New York Times article about him. He’s a very original and creative thinker who looks at things from a unique perspective and I find it very interesting talking with him. To do well in investing, you have to have your own independent view of things and really be thinking about how things work and he is someone who does that. Incidentally, the New York Times had another article about Redleaf, saying that he was really one of the first persons to clearly delineate the subprime crisis that we’re now in. He saw it coming and I have to say, profited from it. If you know the subprime crisis is coming, then there’s always a way to profit from that and that’s what he did. But, he also has a philanthropic side, so it all comes out very well.

Finance and Insurance: Powerful Economic Forces Pt 2

Finance and Insurance: Powerful Economic Forces Pt 1

Another book, which I haven’t put on reserve yet but I’m going to, is by Peter Unger who is a philosopher. It’s a remarkable book called Living High and Letting Die that refers to a more broad philosophical issue that we have. It is that most of us are really making money for ourselves, that’s what we do with our lives and whether or not that is moral.

It’s not just rich people who do that, the rest of us do it also, and in Peter Unger’s book on the first page, he has an address and it’s an for UNICEF, which is the United Nations Children’s Fund, and he starts out his book with that address where you could send money right now. I thought it was very impressive that he put that on page one of the book because it puts the reader in a moral dilemma. He points out that it’s estimated that for every $3 you send to UNICEF, you can save a life.

That’s because there are people in this world who are not getting medical care. There are people who are dying of diseases for which there are known cures because they don’t have the best medicine which are often not even expensive but they’re living in such poverty. So, he says that why don’t you stop right now and send $100 to UNICEF. It was very impactful to start a book that way because I doubt that hardly any readers actually write out a check on the spot to UNICEF. But, if you don’t, then you are in some sense responsible for the loss of lives. So, it’s quite striking and it helps you to reflect on what makes us behave the way we do.

By the way, when you go back to your computer, Google UNICEF, and you can give $100 to UNICEF, you can do it within the hour. Maybe I could ask for a show of hands of how many people did that. I expect that not many of you will and I don’t think that proves that you are bad people – this is a very interesting philosophical question – but what it means is that there is a moral dilemma underlying all of our economic lives and I think this moral dilemma is the same as the moral dilemma in finance. It’s just that people in finance are sometimes very successful and they could give a lot more than $100 to UNICEF.

One thing that I wanted to emphasize in this course or try to emphasize is that part of finance is actually philanthropy. The most important, the most successful people in finance, I believe, end up giving the money away and that means you can’t consume a billion dollars. There’s no way that you can do that. You can only drive one car at a time, right? And if you have five cars, well, I mean that’s kind of – all right, you could have five cars and you could drive a different one every day, but it’s starting to seem a little ridiculous, right? At any rate, you’re not using them and they’re going to end up being used by somebody else. So, I think the outcome should be philanthropy and those of you who are successful really ought to give it away.

Finance and Insurance: Powerful Economic Forces Pt 1

Global Economic Outlook Pt 7

So this homework to be done country by country is going to be very important so every single country should keep his house tidy and clean and then international orgranizations, they are important tools but they are not a substitute for the homework to be done in every single country.

A more coordinated action is absolutely necessary in the Euro Zone.  We hope that the fiscal compact, we hope that this works and it is absolutely necessary to implement this in the Euro Zone without any slippages.  And also G20 I think has a big role also.  Probably under utilized but an important role to have a better global coordination of the policies.  And it’s very important today, during this year  for the countries within G20 not to just follow their own national interest but also think about the global outlook, feel the global responsibility because as Christine said at the very beginning, we are living altogether and if there’s a serious collapse anywhere in the world, it’s going to hurt all of use.  Nobody is going to have a better condition because of a collapse, serious collapse elsewhere in the world.

So, specific to Turkey as Martin has asked.  We have been very prudent on fiscal side and in 2009 we announced a very prudent  tight fiscal policy and medium term fiscal program to even further reduce our deficits and many people had picked on us because they told us “look at Europe, look at everyone else, everyone else is increasing spending and you are doing the reverse”.  But it paid off very well.  The confidence was built up, growth rate was 9% in 2010, 8% in 2011.  We have actually been tightening things to contain the growth to prevent overheating.  We have followed quite a different path from the rest of our European neighbours.

Thank you very much and let me turn now last to Asia and start with Japan in Asia and with you Minister Furokawa please.

Thank you very much.  Let me start with the landscape of Japanese economy.  We have had a relatively stable economic growth rate  and low unemployment rate and we are determined to continue  to the final stabilization of the Euro Zone.  The current government debt crisis in Europe inevitably affects the glob al economy.  With this in mind, we expect that Europe makes effort to manage  the challenges and endeavours to salvage the fireball to calm down the market.

Japan has been supporting this effort  as a major purchaser of EFSF Bonds currently holding 16% of the outstanding issues.  Further engagement of the international community is required.  Japan will collaborate closely  with other countries and relevant parties in supporting Europe’s firm actions.  However, I have somewhat of a concern that the crisis may also have a financial effect outside Europe specially on the capital shortage in Asia.  Japan will intensely concentrate its effort to save off the capital outflow and proactively commit to Asia’s sustainable growth

The issues we are currently facing  are not limited to the debt crisis in the Euro Zone.  I would like to point out more common and underlying issues.  This year, social collectiveness and trust will be tested all around the world because of a number of destabilizing factors.  These factors are low economic growth rates, high unemployment rates and continuous debates in election campaigns.  In confronting these challenges, the Japanese government  is now working on composing a new growth model that pursues three elements altogether namely, the economic growth, social inclusiveness, and environmental sustainability.

Japan will closely collaborate with the economies of Asia and the OECD countries in this effort.  We should pursue this dynamic and inclusive growth because mere economic growth will not resolve the dissatisfaction in the current economic system.  As you witnessed, last year occupied Wall Street and a popular uprising in many countries are typical examples.  Following this annual reform, I am looking forward to elaborating for further discussion in the international community.

And lastly, I would like to comment about Japan’s fiscal deficit issue.  It’s important to note that Japan’s fiscal deficit issues is a pressing issue in terms of its volume.  At the same time, it’  also important to note that vast majority of the debt is financed by domestic savings.  We don’t think this structure will cause immediate crisis. However, tapping fiscal consolidation is a pressing challenge we cannot leave behind.

Our government has been working on these issues since fiscal year 2010 aiming to have the primary debt to GDP ratio in five years both raising the consumption  tax rate in a phase manner and promoting economic growth through implementing the strategy for rebirth of Japan are key components.  They are the wheels of the same car.

Thank you very much.  I am very glad that you brought in Japan’s fiscal position since we’ve had some very strong positions on this issue of fiscal austerity which a number of people prefer to.

Davos 2012 – Global Economic Outlook Pt 7
economics expert witness

Global Economic Outlook Pt 6

Thank you very much.  The issues you have raised we will absolutely come back to if it’s all possible.  Pretty all of them I think.  Let me turn you now to Deputy Prime Minister Mr.  Babacan.  Perhaps I very much want you to talk about your own country in the region, lots going on.  What are the economic  significance of that.  It’s obviously a very big issue.  Also, obviously you have a, I don’t know if we can describe this as a privileged position but ring side seat on the Euro Zone, a disaster…sorry, I didn’t mean that, of events and I know you have views on it.  And also, particularly relevant because Turkey, of course , had a financial crisis quite recently in the last decade and it has gone through that and has coped with this crisis from this point of view remarkably well so I know that you have lessons to teach us as well.  So what is your perspective on where we are?

Well, if I may talk about the current  global economic situation and most specifically what is going on  in Europe and the Euro Zone and if we really want to see sustainable growth, job creation, employment and so forth, there is one  very important concept which I think we have to emphasize over and over again and that is confidence.

When we don’t see a medium of confidence, when consumers don’t have trust for the future, they don’t spend.  When corporations don’t have confidence, they don’t invest and when banks have doubts about our future, they don’t lend.  And when these don’t happen, the economy stops, the financing channel stops and we don’t see growth.

How to attain confidence, how to regain confidence should be at the core of the policies in many, many countries.  For those countries where public debt is a source of concern, we don’t think that fiscal stimulus will work.  If  a country already has high debt and if this debt creates a lot of doubts in the markets, simply trying to spend  more has some kind of growth through just government spending and in Euro Zone there has been some unfortunate trials in 2008, 2009, trying to give fiscal stimulus and had a very unfortunate results at the end of the day.

For those countries where public debt is reasonable, and for those who have some physical space, maybe there might be some efforts but what is most important here is about fiscal policies.  There’s an asymmetry.  It is always easy to losen fiscal policies.  So then in 2008 and 2009, many European governments said okay, this is going to solve the problems but then it is time to tighten the policies.  It is very, very difficult.  It has many costs, it costs the fortunes of the leaders, it costs the fortune of the political parties in many countries and thinking about the fact of that sensitivity, the fiscal policies, it is important to be on the prudent side when it comes to budget and public debt and so forth.

Once keeping the fiscal policy at a prudent phase, then for countries it is very important to have a very clear strategy and communicate the strategy very well so that the strategy is owned by the masses because if there is no local ownership of the policies, then probably those policies will not work.  Do people understand?  Do citizens of that country understand?  Do they really understand the necessity of the steps, maybe difficult steps that is needed for the future.

And then having  a medium term vision is also very important.  Now I have attended many, many discussions  in Davos and we have been talking too much about 2012 but if we are going to talk about growth and employment, it is not just the single one year we have in front of us.  We have 2013, 2014 and for some policy  actually, it might be hurting growth in the short term today but it may generate more and sustainable growth  later on so we should probably look at growth and job creation with a medium term approach and the governments announcing these medium term programs is going to be very, very crucial to bring some predictability about what is going to happen.

If the companies or the financial sector doesn’t have any idea about what’s going to happen in this year in the United States, if we all have big doubts about what’s going to turn out in the Euro Zone this year and if all the mass media is broadcasting this, how to expect people to spend more, how to expect companies to continue investment  or hiring people and how to invest…the banks, although they have much liquidity in their hands to do their function of lending.

Davos 2012 – Global Economic Outlook Pt 6
economics expert witness