Avoiding Future Financial Crises
Recovery is stalled because we suffer from structural rather than just cyclical constraints on growth. Current economic policies are ill-conceived and need to be changed and this should be the major priority for policy. But we must at the same time avoid policies that precipitate another financial crisis. The creation of massive fiscal deficits was successful in moderating the impact of the last one. It is politically improbable that we could introduce another large increase in these deficits were we to hit another crisis and it is doubtful whether this would be sensible in economic terms. We have also reduced interest rates to near zero and, although the unorthodox monetary policy in which central banks buy bonds may have helped, there are widespread doubts both about its continued benefits1 and its possible risks.2 While it should always be a major aim of policy to avoid financial crises, the need today is greater than ever as the ammunition that was used to mitigate the consequences of the last one has been expended and is no longer available. It is therefore essential to analyse the causes of previous crises so that we do not repeat the errors that led to them.
There have been three, and happily only three, examples of financial crises in the past 100 years that have caused severe and sustained losses of output. They were the slump of the 1930s, which followed the Wall Street crash of 1929, the stagnation of the Japanese economy, which followed ...