Q&A with Karma Hadjimichalakis

Interview with Karma Hadjimichalakis Principle UW Lecturer, Everett McKay Faculty Fellow, Foster School of Business

KCTS9: Is it better to spend money or save money in this economy?

KH: The time for consumers to restore their savings, it would be best for the economy, is when the economy is booming. Because if the consumer steps down and saves more, there will be some other player in the economy who’s likely to step up their spending. Businesses may spend more on capitol goods or export more.

So there will be some replacement for the loss in consumer spending. On the other hand, if we’re in a bust, as we are now, and the consumer steps down, the question is, who is going to step up. Consumption is 70% of all spending so consumption is key. So with less consumption, at the same time that firms are retrenching and exports are falling, what that does is make the downturn worse.

KCTS9: How does the housing mess tie in with the weak economy?

KH …What we have is this, vicious cycle, housing prices fall, and more people default on their mortgages and what that means is that, the economy gets weaker. And as the economy gets weaker, what you get is this vicious cycle then of more defaults. So we have this feedback loop from the housing sector to the banking sector, to the demand of goods and services, back to weak credit.

KCTS9: What is the government doing to stop the housing foreclosure problem?

KH: One of the key dilemmas and why its taking time to work out is, that they want to mitigate foreclosures, but suppose somebody’s house, their mortgage is under water, which means they got a mortgage for $500,000, but now their home is only valued at $400,000, so some of those people are going to walk away from their loan.

Because the government has no recourse to any of their assets, so some of those will just walk away. Why pay this mortgage? What the government is trying to figure out now and to model, who’s most likely to walk away, and who will continue to pay their mortgage. Because we really don’t want to subsidize those people, who will willingly continue to pay their mortgage, hoping that the housing prices will rise. They want to keep a good credit record.

KCTS9: Can the government spend it’s way out of this mess?

KH: Well what the government needs to do is lean against the wind…it needs to spend when all other components are of spending are falling. So right now what are the other components?—consumption of houses, that’s going down; spending on new houses is going down…Spending by firms on plant equipment, that’s going down; exports are going down. So everything else is going down, so the government leans against the wind and it has to increase its spending or cut taxes to try to boost other spending. Now the other part of it is, and that the part that we often forget, is that when the economy improves, leaning against the wind means that the government’s going to have to pull back on its spending. So the government should be…the government could be running deficits in tough times, but it needs to reduce those deficits when the economy gets healthier.

KCTS9: How long will this recession last?

KH: The National Bureau of Economic Research is the non-profit agency that dates the beginning and end of recessions. And they date them, they don’t forecast them, so they wait until they have enough data to date the beginning. So in December of this, of 2008, they told us the recession started in December of 2007. So actually when they dated it, it was already one year old. This year, growth is forecast to be negative, that we’re going to have a decline in the economy this year. So I think we’ll be fortunate if the trough of the economy is reached at the end of 2009. But having said that that doesn’t mean that we’re going to bounce back in 2010 very vigorously, so growth could still be sluggish in 2010.

KCTS9: Is this a global recession?

KH: Yes it is a global recession. You know at one time a few years ago we talked about decoupling, and I always thought that decoupling was a myth…and the idea was that even if we slowed down, that the rest of the world—the developing world, like China and India—could stay strong enough to sort of offset our downturn. But that isn’t what has happened at all. This slowdown, which was made in the U.S., has spread through the rest of the world, through I think two channels: trade and fear. So if you look at China for instance, China’s financial sector has not in any way been involved with the crisis in the U.S. in the sense that it hadn’t bought any of these toxic assets like European banks have, and it hasn’t been involved in the type of lending that we have been involved in. So China and Japan directly have not been involved in the financial crisis. And yet their economies are suffering.

KCTS9: Will there be a positive outcome to these tough times?

KH: When we get back to an economy that’s closer to potential and we will get there. There will be some positive effects. If, for instance, we change our mix of spending, so if when we’re back in a healthy economy actually the American consumer has, does, built up some of their savings, and we consume less, and we have more spending coming from firms spending on plant equipment, and if we have more spending on exports because we’re selling more to the rest of the world.

That will also depend on the rest of the world changing their ways. Because that means developing countries aren’t going to be able to just count on growing by selling to us. They’re going to have to increase their domestic demand. And sell less to us. And that will be a healthier mix with fewer imbalances. And of course the other thing is that we will hopefully have a healthier financial sector. Right now we’re dealing with sort of all the problems, but in the longer term the government has to and will take a longer and hard look about restructuring the financial system.

Q&A with Karma Hadjimichalakis

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