1. Loyola University Chicago The Catholic University of Leuven,
U.S. ECONOMIC POLICIES THAT CONTRIBUTED TO THE GLOBAL FINANCIAL CRISIS OF
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
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?

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

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

10. Major Asset Bubbles and Crashes
1929 US: Stock Market Crash
1989 Japan: Real Estate and Equities
2000 US: NASDAQ
US: Housing and Credit Bubbles

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

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

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

14. 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)

15. 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

16. 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)

17. Productivity and Real Fed Rates

22. 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

24. 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

26. The De-Leverage Cycle

28. 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

29. 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

30. 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