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U.S. ECONOMIC POLICIES THAT CONTRIBUTED TO THE GLOBAL FINANCIAL CRISIS OF 2007-09

U.S. ECONOMIC POLICIES THAT CONTRIBUTED TO THE GLOBAL FINANCIAL CRISIS OF 2007-09. A.G. Malliaris Loyola University Chicago Fourth European Conference on the Welfare State and the Global Financial Crisis The Catholic University of Leuven, 19-20 April 2010. Focus of the Presentation.

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U.S. ECONOMIC POLICIES THAT CONTRIBUTED TO THE GLOBAL FINANCIAL CRISIS OF 2007-09

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  1. U.S. ECONOMIC POLICIES THAT CONTRIBUTED TO THE GLOBAL FINANCIAL CRISIS OF 2007-09 A.G. Malliaris Loyola University Chicago Fourth European Conference on the Welfare State and the Global Financial Crisis The Catholic University of Leuven, 19-20 April 2010

  2. Focus of the Presentation • Global Financial Crisis of 2007-09 • Financial Instabilities of Market Economies • U.S. Asset Bubbles • U.S. Monetary Policy • All Are Interrelated Issues

  3. Financial Instabilities • Keynes: capitalism is unstable • U.S. choice between freedom and regulation • Financial stability means the efficient allocation of funds to investment opportunities • F. Mishkin: adverse selection and moral hazard: bank soundness • Slow return to the pre-shock state

  4. Financial Instabilities • Financial instabilities increase uncertainty and generate risks • Valuation risks: valuing securities during a financial distress • Macroeconomic risks: deterioration of the real economy

  5. Asset Price Bubbles • Asset Bubbles and Instabilities • Controversial Topic; Market Efficiency • Kindleberger: “An Upward Price Movement Over an Extended Range that then Implodes” • Soros on Reflexivity • Keynes, Minsky, Shiller on Animal Spirits • Preconditions for Bubbles?

  6. Evolution of Bubbles • Some Deflate • Some Crash • Some Do not Affect the Real Economy • Some Cause Serious Economic Damage

  7. Monetary Policy • Price Stability • Economic Growth • Risk Management Approach to Financial Instabilities • Reservations of Anna Schwartz

  8. Major Asset Bubbles and Crashes • 1929 US: Stock Market Crash • 1989 Japan: Real Estate and Equities • 2000 US: NASDAQ • 2007-9 US: Housing and Credit Bubbles

  9. Bubbles and Monetary Policy • Two Questions • Normative: Should Monetary Policy Target Asset Prices? • Positive: Does Monetary Policy Target Asset Prices?

  10. The Normative Question • Bernanke and Gertler: The Fed Should Not Target Asset Prices • Cecchetti and Others: React Cautiously • Filardo: Deflate Bubbles • Roubini: Burst Bubbles

  11. Positive Question • Hayford and Malliaris: Difficult to Assess Fed’s Policy • Greenspan: Appears to Have Tried • Using an Axe to Do Brain Surgery

  12. Conceptualizing the Debate • Monetary Policy is Symmetric: increase Fed funds as bubbles grow and decrease them when they crash • Monetary Policy is Asymmetric: ignore bubbles until they burst, then lower Fed funds to minimize problems to the real economy (Greenspan’s put)

  13. The Asymmetric Approach • Greenspan’s clarification • Some support from the historical record • Central Bankers appear skeptical about the theoretical simulations • Targeting bubbles may destabilize the real economy • There is no political consensus for targeting bubbles

  14. Origins of the Financial Crisis • Among various causes, consider the role of monetary policy in the U.S. • Did the Fed contribute to the housing bubble? • Yes (Taylor); No (Greenspan)

  15. Productivity and Real Fed Rates

  16. Sequence of Bubbles? • Are the Internet Bubble Bursting and the Housing Bubble Connected? • How About the Commodities Bubbles? • Global Dimensions: Savings Glut • Huge Demand for Long-term AAA’s

  17. The Bursting of the Housing Bubble • Late 2006 Housing Prices Peaked • Early 2007 Funds Investing in Home Mortgages experienced problems • The De-Leveraging Process Started • The U.S. Crisis was globalized

  18. The De-Leverage Cycle

  19. U.S. Policies and the Global Financial Crisis: Lessons • From the Great Moderation to Asset Bubble Accommodation • Deregulation of Financial Markets • Multiple Bubbles Globally • Risk Management Difficulties and Insufficient Corporate Governance

  20. U.S. Policies and the Global Financial Crisis: Further Lessons • Substantial Leveraging • Private Sector Risk Management: Showers vs. Storms • Systemic Risk and Financial Stability • The Role of the U.S. Treasury and the Fed • Principles of Crisis Management: Act Rapidly, Decisively and Forcefully

  21. U.S. Policies and the Global Financial Crisis: Further Lessons • Crises in Emerging Nations vs. Developed Nations such as the U.S. • U.S. Policies to Address Future Crises Remain Uncertain • Global Imbalances Persist

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