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Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis

01 Feb 2009-
TL;DR: In this paper, the authors explain what caused the current financial crisis, what prolonged it, and what worsened it dramatically more than a year after it began, and suggest a set of principles to prevent misguided actions and interventions in the future.
Abstract: Throughout history, financial crises have always been caused by excesses - frequently monetary excesses - which lead to a boom and an inevitable bust. In our current crisis it was a housing boom and bust that in turn led to financial turmoil in the United States and other countries. How did everything deteriorate so suddenly and dramatically? In Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, Hoover fellow and Stanford economist John B. Taylor offers empirical research to explain what caused the current financial crisis, what prolonged it, and what worsened it dramatically more than a year after it began. The author tells how unusually easy monetary policy helped set the crisis in motion, as interest rates at the Federal Reserve and several other central banks deviated from historical regularities. He explains monetary interaction with the subprime mortgage problem, showing how the use of these mortgages, especially the adjustable-rate variety, led to excessive risk taking. In the United States this was encouraged by government programs designed to promote home ownership, a worthwhile goal but overdone in retrospect. Looking ahead, the author suggests a set of principles to follow to prevent misguided actions and interventions in the future.
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18 Sep 2013
TL;DR: The EFW index as discussed by the authors ranks countries around the world based on policies that encourage economic freedom, and places Australia at number 10 in the list of countries with the highest economic freedom.
Abstract: This report uses 42 distinct variables to create an index ranking of countries around the world based on policies that encourage economic freedom, and places Australia at number 10. Executive summary The index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries are supportive of economic freedom. The cornerstones of economic freedom are personal choice, voluntary exchange, freedom to compete, and security of privately owned property. Forty-two variables are used to construct a summary index and to measure the degree of economic freedom in five broad areas: 1 Size of Government; 2 Legal System and Property Rights; 3 Sound Money; 4 Freedom to Trade Internationally; 5 Regulation. Since our first publication in 1996, numerous studies have used the data published in Economic Freedom of the World to examine the impact of economic freedom on investment, economic growth, income levels, and poverty rates. Virtually without exception, these studies have found that countries with institutions and policies more consistent with economic freedom have higher investment rates, more rapid economic growth, higher income levels, and a more rapid reduction in poverty rates. The EFW index now covers 152 countries and territories. Data are available for approximately 100 nations and territories back to 1980, and many back to 1970.3 This data set makes it possible for scholars to analyze the impact of both cross-country differences in economic freedom and changes in that freedom across a threedecade time frame.

1,010 citations

Posted Content
TL;DR: This paper presented a database of systemic banking crises for the period 1970-2009 and found that direct fiscal costs to support financial sector were smaller this time as a consequence of swift policy action and significant indirect support from expansionary monetary and fiscal policy, the widespread use of guarantees on liabilities, and direct purchases of assets.
Abstract: This paper presents a new database of systemic banking crises for the period 1970-2009. While there are many commonalities between recent and past crises, both in terms of underlying causes and policy responses, there are some important differences in terms of the scale and scope of interventions. Direct fiscal costs to support the financial sector were smaller this time as a consequence of swift policy action and significant indirect support from expansionary monetary and fiscal policy, the widespread use of guarantees on liabilities, and direct purchases of assets. While these policies have reduced the real impact of the current crisis, they have increased the burden of public debt and the size of government contingent liabilities, raising concerns about fiscal sustainability in some countries.

786 citations

Journal ArticleDOI
TL;DR: In this article, the authors studied how high leverage and crises can arise as a result of changes in the income distribution and presented a theoretical model where these features arise endogenously as a shift in bargaining powers over incomes.
Abstract: The paper studies how high leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2007 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where these features arise endogenously as a result of a shift in bargaining powers over incomes. A financial crisis can reduce leverage if it is very large and not accompanied by a real contraction. But restoration of the lower income group’s bargaining power is more effective.

629 citations

ReportDOI
TL;DR: In this paper, the authors examine what we have learned and how we should change our thinking about monetary policy strategy in the aftermath of the 2007-2009 financial crisis and how much of the science of monetary policy needs to be altered.
Abstract: This paper examines what we have learned and how we should change our thinking about monetary policy strategy in the aftermath of the 2007-2009 financial crisis. It starts with a discussion of where the science of monetary policy was before the crisis and how central banks viewed monetary policy strategy. It will then examine how the crisis has changed the thinking of both macro/monetary economists and central bankers. Finally, it looks how much of the science of monetary policy needs to be altered and draws implications for monetary policy strategy.

403 citations

Journal ArticleDOI
TL;DR: In this paper, the authors argue that the main contributing factor to the financial crisis was not "excess saving" but the excess elasticity of the international monetary and financial system, which failed to restrain the build-up of unsustainable credit and asset price booms ("financial imbalances").
Abstract: Global current account imbalances have been at the forefront of policy debates over the past few years. Many observers have recently singled them out as a key factor contributing to the global financial crisis. Current account surpluses in several emerging market economies are said to have helped fuel the credit booms and risk-taking in the major advanced deficit countries at the core of the crisis, by putting significant downward pressure on world interest rates and/or by simply financing the booms in those countries (the "excess saving" view). We argue that this perspective on global imbalances bears reconsideration. We highlight two conceptual problems: (i) drawing inferences about a country's cross-border financing activity based on observations of net capital flows; and (ii) explaining market interest rates through the saving-investment framework. We trace the shortcomings of this perspective to a failure to consider the distinguishing characteristics of a monetary economy. We conjecture that the main contributing factor to the financial crisis was not "excess saving" but the "excess elasticity" of the international monetary and financial system: the monetary and financial regimes in place failed to restrain the build-up of unsustainable credit and asset price booms ("financial imbalances"). Credit creation, a defining feature of a monetary economy, plays a key role in this story.

386 citations


Cites background from "Getting Off Track: How Government A..."

  • ...36 For another analysis highlighting the role of monetary policy, see Taylor (2008)....

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  • ...4 For a similar conclusion, which plays down the role of global imbalances, see Truman (2009)); see also Shin (2009), who stresses the need to consider the important role played by monetary policy....

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