Tags: taylor | savings | crisis | 2008

Stanford’s Taylor: ‘Saving Glut’ Didn’t Spark 2008 Crisis

Thursday, 05 Jul 2012 02:32 PM

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Stanford economist and Hoover Institution senior fellow John B. Taylor says low interest rates and international capital flows were to blame for the 2008 crash.

Writing in The Wall Street Journal, Taylor notes that the Bank for International Settlements — the central bank of central banks — has warned about the harmful "side effects" of current monetary policies "in the major advanced economies" where "policy rates remain very low and central bank balance sheets continue to expand."

These policies "have been fueling credit and asset price booms in some emerging economies," the BIS reported, noting the "significant negative repercussions" unwinding these booms will have on advanced economies.

"The BIS should be taken seriously," says Taylor. "It warned long in advance about the monetary excesses that led to the financial crisis of 2008."

Low interest rates cause investors to search elsewhere for yield, and they buy foreign securities — corporate as well as sovereign — for that reason.

“Global bond funds in the U.S. thus shift their portfolios to these higher-yielding foreign securities and investors move to funds that specialize in such securities,” says Taylor.

Moreover, low U.S. interest rates also encourage foreign firms to borrow in dollars rather than in local currency, putting upward pressure on the exchange rate in these countries, as the foreign firms sell their borrowed dollars and buy local currency to expand their operations and pay workers.

Central banks buy dollar assets, including mortgage-backed securities and U.S. Treasurys, to keep the value of their local currency from rising too much as against the dollar, notes Taylor.

“One consequence of these purchases is a foreign government-induced bubble in U.S. securities markets, as we saw in mortgage markets leading up to the recent crisis, and as we may now be seeing in U.S. Treasurys,” he says.

“The flow of loans from the U.S. to foreign borrowers is effectively matched by a flow of funds by central banks back into the U.S. There is no change in the current account, and no role for the so-called savings glut.”

CNBC reports that China's central bank cut interest rates for the second time in two months to bolster an economy widely expected to record its sixth-successive slide in growth in April-June.

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