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How hot can we get? We are in Europe after all, right?

Aram Klijn
Aram Klijn is currently a first year Bsc Economics student. He is especially interested in macroeconomics, international trade and anything related to music.

Nearly all financial news of the past few months has been focused on one thing: a world economy in danger of overheating. Plenty of warnings, yet change does not seem to be on the horizon. Is this an unavoidable human desire to forget the evil past and dive headfirst into another mistake? Is it impossible to change this cycle?

Nearly all financial news of the past few months has been focused on one thing: a world economy in danger of overheating. Plenty of warnings, yet change does not seem to be on the horizon. Laissez-faire economics may be a great way of letting a hot or overheating market sort itself out – plenty of competition to go around when all goes well. However, it also increases the risk of everything tumbling down off an ever growing cliff (or at least, further than it may have otherwise). European governments mostly remain healthily hesitant to invest large sums of money at this time, but Trump’s administration seems adamant to Make America Great Again – possibly too great even. His tax cuts are estimated to pile up another 1 trillion dollars on the already sizeable American government debt mountain. His tariffs on Chinese steel and aluminium are also hardly a way of lowering the government debt.

As Job Teurlinx already illustrated in his earlier article ‘The end of crises: can we reach financial stability’: “don’t we forget something? Something that cannot be grasped in rules or in numbers, but plays a very important role. It’s optimism, culture: the propensity to take risks – really believing that it’ll be all right, while making old mistakes again because you forgot how bad things could be.” Is this an unavoidable human desire to forget the evil past and dive headfirst into another mistake? Is it impossible to change this cycle?

Multiple economists have argued to fundamentally ‘change the system’, from the roots up. This may, from a political and economic point of view, be a bit of a stretch, but what can be done? One of the more compelling arguments comes from Atif Mian and Amir Sufi. Their book ‘House Of Debt’, is universally lauded because ‘it could be the most important book to come out of the 2008 financial crisis and subsequent Great Recession. (Summers, 2014).They argue that the American mortgage system, now fully reliant on the income and financial stability of the debtor, should be replaced with an equity-based risk-sharing system. This would remove part of the burden from the debtor and encourage banks to use their assets responsibly too. This would reduce both the consumption decrease that heavily indebted households experience during economic crises, as well as lower the risk of bankruptcies, underwater mortgages and fire sales. This would be a relatively small political step to make, but a big step for the economic safety of mortgage-holders.

Small adjustments will not prevent crises, but they may be able to stem the bleeding when a crisis does happen. Other band-aid measures suggested include a ‘rainy-day fund’ for the Eurozone, as suggested by Christine Lagarde of the IMF. This fund would be able to, at least partially, save failing Euro countries when their economies collapse. A voluntary European Stability Mechanism (ESM), if you will. So far, most of the measures that have been taken are regulatory. Politics’ response, both within countries and in the Eurozone has mostly concentrated on better financial regulation and decreased upper bounds to the amount of mortgage one can borrow. Certainly not a bad idea, but hardly revolutionary. Hopefully the Great Recession has convinced politicians to start shifting policy before a recession starts. The European desire to lower government debt and be hesitant of investment is at least a step in the right direction, a step that hopefully will continue to be taken.

Bibliography
Summers, L. (2014, June 6). Lawrence Summer on ‘House of Debt’. Retrieved from Financial Times: https://www.ft.com/content/3ec604c0-ec96-11e3-8963-00144feabdc0

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