The Role of Savings Rate in the Economic Crisis White Paper
When considering the current economic crisis we can discern that variables of two diﬀerent types contributed to its creation and magnitude. The ﬁrst are the real variables that caused the initial imbalance in the economy. The second variables are the nominal ones, which are usually catalysts that accelerate situations. Metaphorically, the real variables can be compared to ﬁre and the nominal ones to the fuel. Considering the way the crisis evolved, there is a clear view of the chief real variable that caused the crisis. This variable is the change in the savings rates, primarily in the US.
If we brieﬂy review the history of the crisis, we see that the ﬁrst signals of genuine economic instability began to appear in the ﬁrst half of 2007, when a large wave of sub-prime mortgage lenders in the United States became insolvent. However, the seeds of the crisis were planted many years before. The United States created a deﬁcit in its current account that grew steadily throughout the last decade. The deﬁcit on one side of the ocean created surplus on the other side, especially in countries like China and Singapore. These countries then loaned the surplus back to the US so that it would be able to continue buying imports. Usually, a current account deﬁcit is highly correlated with a government deﬁcit, and the data from years before the crisis show that the US is no diﬀerent. During this period, several bubbles were created in the American economy. The ﬁrst bubble appeared in the lending market, led by the housing market where mortgages are granted to sub-prime borrowers and prime borrowers with low self-equity. These loans expanded beyond all reasonable proportions because of the ﬁnancial system’s eagerness for short-term proﬁts. This eagerness was ignited by short-term incentive contracts signed with managers of ﬁnancial companies or what is known professionally as the “principal-agent problem.” Simultaneously, mortgages became securitized, which created an additional problem when rating companies granted these securities AAA ratings despite the high risk levels. The lack of supervision over the highly-inﬂuential rating companies working in an unregulated branch exacerbated the crisis.
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