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Mohamed El-Erian's Bagehot Lecture From Buttonwood


A handful of major forces may be extremely useful in shedding light on most, albeit not all, of what is happening in the global economy today.

The third risk has to do with the US and its fiscal cliff. Were it to materialize, this self-created challenge would unambiguously push the country into recession, with widespread adverse consequences.

This is not our baseline. We believe that, following the November elections, there is a 60%–70% probability that politicians will iterate to a "mini bargain" involving around 1.5% of GDP (via a more orderly fiscal contraction), rather than a disorderly contraction of some 4% of GDP.

Then there is China. Many are rightly concerned about the twin challenges of reacting to slowing global demand and navigating the inherently tricky "middle income transition." And as Michael Spence has noted, only five countries have navigated this transition at high speed; and none were as large and complex as China.

Finally, geopolitical risk remains high in Middle Eastern countries – and especially Iran – where, to use Tom Friedman's characterization, instability risks "explosion" rather than "implosion" when it comes to regional network effects.

Given the extent of these risks, it is understandable that economists tend to focus on left tail analysis; and they should, given the Pascal's Wager nature of the potential payoffs. But this should not preclude us totally from recognizing the components of the right tail.

What we are ultimately talking about is an "unusually uncertain" distribution of potential baseline outcomes, as well as unusually shaped tails. This inevitably undermines the robustness of lots of conventional wisdom, as well as a range of historical contracts and entitlements. It also challenges the agility of institutions in both the public and private sectors.

What is needed in today's world is different. Drawing from the work of Don Sull, [author of The Upside of Turbulence: Seizing Opportunity in an Uncertain World]; it is about the right mix of absorption and agility; that is to say, a mix that enables economic agents both to respond to opportunities and to be able to afford their unintended mistakes. And it will only work for societies and regions as a whole if there is much greater recognition of the need for shared responsibilities and cooperative outcomes.
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