Saturday, October 11, 2008

Economists Offer Sensible Solutions to the Crisis

Here's an article in the WSJ on sound proposals to solve the financial crisis offered by academic economists (HT Mankiw). Many economists have criticized the government's bailout plan as approved by Congress:

Many economists believed that the heart of the government's initial plan to pay $700 billion for toxic assets was aimed at the wrong target. Purchasing mortgage securities from banks wouldn't do anything to kick-start lending and get credit flowing again, they said. Rather, banks would use the proceeds they got from the Treasury to pay off debtors, and those debtors would use the proceeds to buy safe assets.

... Other hitches in the original plan include coming up with a price for mortgage securities that is above the "fire sale" level they would draw on the open market, but not so high that taxpayers end up getting taken for a ride.

Academic economists came out with much wiser proposals, in the hope that government will be hearing. Here is an interesting idea by Mankiw, which would preserve the role of free enterprise in the system and avoid the dangers of government failure:

The economists came from different schools of thought and varying political stripes but all agreed that recapitalizing banks was a key initiative. ...

Harvard University economist Gregory Mankiw, former chairman of the Council Economic Advisors under President George W. Bush, suggested that the government could set up a recapitalization plan that works like a matching grant. If a financial institution attracted new capital from private investors, it would be able to access an equal amount of government capital.

"The private sector rather than the government would weed out the zombie firms," he wrote on his blog. "The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control."

And here is DeLong on how to stimulate the economy:

A final step toward stabilizing the economy would be a large economic stimulus plan, said Berkeley economist Brad DeLong. He suggests that in the U.S. this could be two-tiered, with half the stimulus going toward a tax rebate and the other half dedicated to infrastructure spending.

Mr. DeLong said he is encouraged by how quickly economists' thoughts on the crisis have made it into the public sphere.

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