Macroeconomic Vulnerabilities in the 21st century

Brad Delong wrote this prophetic paper in 2002.

He begins the paper asking this question – What will the macroeconomic vulnerabilities of the 21 century be? Before this he points to five macroeconomic vulnerabilities of the 20th century:

  1. Recessions and depressions could be caused by large confidence shocks
  2. Recessions and depressions could be caused by overly contractionary mon policies
  3. Recessions and depressions could be caused by small shocks combined with a self-enforcing debt deflation mechanism
  4. High inflation could be caused by loss of central bank’s reputation for caring about price stability
  5. High inflation could be caused by interaction of persistent deficits and politically driven need for central bank to be financer of govt deficit.

He says, would we see the same vulnerabilities as seen in the 20th century or different ones because of ongoing technological revolution.

Before listing the five vulnerabilities for the 21st century, he says these are at best informed guesses. He says there are 5 factors that carry changes in points of vulnerabilities in the 21st century. He divides them into sections:

Magnitude of macro shocks

  1. Faster productivity growth and greater uncertainty could lead to asset market shocks. Waves of euphoria could lead to overestimation and a burst later
  2. If IT really is useful it could be lead to better inventory management and lower the inventory component of the business cycle. This could actually be a positive factor

Policy responses to shocks

  1. A Tech-driven boom could lead to degrading govt’s ability to carry out macro management. The end of euphoria will lead to lower investment and make it difficult for govt to manage the situation
  2. Faster productivity could lead to better labor markets. This again is a positive
  3. Difficulties of surveillance with increasing financial complexity. It is essential for govt regulators to understand the capital structure and portfolio risk profile of financial firms.

So three factors could lead to worse outcomes and two to better ones.

He goes on to explain these five factors in details.

Well, the paper’s predictions  have been tested is the first decade of the 21st century itself.

First, the 20th century vulnerabilities have again hit us in 21st century.  Recession was caused by both a large confidence shock. The scares about debt-deflation mechanism and a depression was avoided by a huge monetary and fiscal stimulus. Though some continue to argue to increase the size of the stimulus.

In the 21st century list,

  1. asset market shock – obviously there. We have seen two actually dot-com in 2001 and housing followed by all asset classes in recent crisis
  2. Infact, IT actually led to a global crisis via the global supply chain. The companies cut production across the globe. So it helped them cut down huge losses but also led to a sharp downward spiral in other economies.
  3. The govt was clearly caught unaware and initially was unable to manage the crisis.
  4. The labor markets have improved as we see virtual immigration has not really suffered in this recession. But still we need much more work in this area.
  5. Difficulty to manage financial sector surveillance. I don’t need to say anything on this….

So we see a bit of both vulnerabilities in 21 century. Old ones from 20th century and new ones from 21st century as Delong puts in his paper.

Bard Delong may have been sceptical writing about the 21st century vulnerability list, but has appeared so true in such a short-time.


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