¡Descarga The Great Recession: Economists' Failure to Prevent Financial Crises y más Ejercicios en PDF de Historia solo en Docsity! An historical perspective on the Great Recession What started as a subprime crisis in the US soon spread to a global crisis resulting in what some have called the Great Recession. This column argues that economists spectacularly failed to take the prevention of financial crises seriously. But since then, economists have heeded the lessons from past crises and have helped avoid the worst. The Great Recession of 2008/9 came as a big shock to economists as well as the general public. They had become accustomed to the serene conditions of the so-called Great Moderation – low inflation, smooth growth, and low unemployment. This led to triumphalist claims that “boom and bust” had been abolished. A complacent belief arose: inflation-targeting by independent central banks will inevitably deliver steady growth with low inflation. Headlines claiming that the inflation targeting at the Bank of England had ushered in the most stable macroeconomic environment in nearly 400 years contributed to this belief – even though the studies cited did not attribute this outcome simply to the success of macroeconomic policy (Benati 2005). Shattered dreams These delusions were decimated by the financial crisis of 2007 and 2008. In the panic that ensued, there seemed to be a real possibility that there would be a repeat of the Great Depression of the early 1930s. Back then, real GDP and prices both fell by more than 25% in the US. One in three US banks failed. A seventh of bank deposits were wiped out – all coming as the catastrophic sequel to the rapid economic growth of the 1920s. In late 2008, Queen Elizabeth II famously asked why no one in the economics profession had seen the crisis coming. The failure of economic forecasters to predict the crisis has been taken by some people to mean that economics as a discipline is totally discredited, as The Economist noted on 16 July 2009 before going on to say that this view was over the top. Certainly, there was an important failure in that, while economic analysis tells us why many banks may fail, economic forecasting is far from being able to say when. Indeed, current “early-warning” models suggested that the risks in 2007 in both the UK and the US were trivial. Yet, at the same time, it has long been understood that market failures in the banking system entail risks of banking crises, which can then lead to big recessions. And it has also been long understood that there are appropriate policy responses (Mishkin 1991). This has allowed economic policymakers to prevent a re-run of the traumas of the 1930s and should inform the design of appropriate prudential regulation to reduce the risks of future banking crises. Looking back A look back at the Great Depression gives us a useful perspective on these issues. A recent issue of the Oxford Review of Economic Policy edited by Peter Fearon and me is designed to expedite this. That crisis also was not forecast, but economic analysis can easily explain the financial debacle of that period and its consequences. Ex-post, there is no great mystery about what went wrong in the US in the early 1930s. We know that the US banking system was fragile; it was based on unit banking, undercapitalised, badly regulated, and had made too many bad loans. On average, the banks that failed had weak balance sheets, which were unable to withstand a recessionary shock (Calomiris and Mason 2003). Bank failures led to a credit crunch and a collapse of the money supply. Monetary shocks and deflationary price expectations produced double-digit real interest rates and investment virtually ceased. In the absence of deposit insurance, there was a scramble to hold cash rather than bank deposits, putting further pressure on banks. The catastrophic outcome was the result of a passive response by the Federal Reserve and could have been largely averted by an aggressive lender of last resort (Bordo and Landon-Lane 2010). Recovery after 1933 required regime change; the US left the gold standard, inflationary expectations were re-established, and expansionary monetary policy created strong demand growth, while banks were re-capitalised and re-regulated (Fishback 2010, Mitchener and Mason 2010). But to develop models to forecast sequences of events such as these would be extremely difficult if not impossible.
