Analysis of the causes of the current monetary/fiscal/economic crisis
The financial crisis that began in 2007 and the resulting economic downturn in the United States and around the world has resulted in a large number of opinions about the causes of the crisis, as well as the policies and actions that are needed to prevent a similar situation from occurring in the future. The opinions that have been provided about how to prevent another financial crisis such as the one that is still impacting countries around the world might be easily categorized as being insider or outsider, with insiders believing that the role of central banks should not change and outsiders believing that central banks should take a more direct role in government policy to stabilize economic conditions.The purpose of this article is to briefly examine some of the arguments that have been presented concerning insider and outsiders views of how to prevent a future financial crisis. The policy implications that have been put forth are discussed, and why it is believed, they can work to prevent a future financial crisis. Based on the ideas that are discussed, a conclusion is presented with which course of action seems most plausible to prevent a future financial crisis.
Policy Recommendations to Prevent Future Financial Crises
The insider view of the current financial crisis is large that central banks were not the cause of the crisis and should not be viewed as the mechanism by which to prevent a similar crisis in the future. Insiders argue that the role in addressing financial problems is in ensuring that proper liquidity is present within a market. Instead, the role of central banks and the policy that they should follow to prevent a financial crisis is in achieving price stability, which is brought about by controlling interest rates and the larger supply of money within an economy. In this way, the call by some that the role of central banks should be expanded so that they become directly involved in monetary policy that is typically the role of national governments should be avoided. In fact, central banks should entirely dismiss the idea that they can control and prevent financial crises because of their ability to print money and to make additional loans available because they can print money.
It may seem that the argument that is made by insiders has been presented with little detail, but the reality is that the lack of change in the role of central banks is the focal point of insiders’ arguments. Instead, insiders argue that if central banks have made any errors in operations concerning the current financial crisis, it has been not to inform politicians, bankers, and the general public that their role is strictly to control the money supply. For insiders, the job of preventing a future financial crisis lies with the financial industry and with policymakers to make rules and take actions that prevent bubbles from occurring.
Outsiders, however, argue that the current financial crisis has demonstrated that central banks should be more directly involved in ensuring that economic growth occurs, which includes full employment, as opposed to only being focused on price stability in the short-term. For some outsiders, it seems as though central banks are only concerned about dealing with the aftermath of a financial crisis, which means that once a crisis has occurred actions are taken to ensure price stability or liquidity.The problem, however, lies in the fact that central banks are already given the task of ensuring price stability so that level rates of growth can occur. If central banks are already working to achieve price stability, their task can shift from responding to changes in economic conditions to attempting to dictate economic conditions by focusing on more long-term trends.
In working to focus on long-term trends, central banks could examine data over time to identify and stop bubbles from occurring. As bubbles are identified, the actions could be taken to notify the public and politicians that bubbles are forming, as well as implement policy changes that would ensure that the bubbles are brought to an end in a safe manner. In this regard, the role of central banks would change to forcing changes in the actions and behaviors of markets and market participants.
Even more, while insiders believe that central banks should not be the lenders of last resort, outsiders believe that central banks should end provide direct lending to banks and financial institutions to prevent a major downturn in liquidity, something which occurred at the beginning of the current economic crisis. Furthermore, insiders believe that central banks should indeed be willing and able to purchase risky assets and to restructure loans to reduce the threat of a further economic downturn and to ensure a high level of liquidity.
Based on the information that has been reviewed, it would seem that the outsider view of the role of central banks to prevent a financial crisis is the appropriate one. The fact of the matter is that central banks are already given the authority to focus on economic stability and growth. Unfortunately, many central bank actions are only about short-term stability and growth without any concern about problems such as financial bubbles. As central banks already act as lenders and attempt to achieve economic stability, they should be able to take on a greater role to be proactive in preventing economic crises rather than only responding to events after they have occurred and then claim that their actions have no impact. If central banks can impact short-term stability and growth, a few changes in how they operate and the mindset with which they operate can allow them to impact long-term growth and stability.