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Fighting Financial Crises: Learning from the Past
Of course, it would be best not to have financial crises. Then there would be no reason to think about how to fight them. But the naive view that advanced economies are no longer vulnerable to financial crises was exploded by the Panic of 2007– 8. So it is necessary to think (again) about fighting crises. Financial crises are devastating events that have long plagued market economies and continue to be a problem. Indeed, crises like the Panic of 2007– 8 are certainly not rare in US history (or, for that matter, in the history of all market economies). Before the Panic of 2007– 8, the United States endured what might be perceived as a recurrent pattern of financial crises, with panics in 1797, 1814, 1819, 1825, 1833, 1837, 1857, 1861, 1864, 1873, 1884, 1890, 1893, 1907, 1914, and 1929 – 33. Each event combined financial distress with economic contraction; the final date in the list is the Great Depression, a monolithic enigma for economists. The depression— a watershed event for policy responses to crises and the aftermath— stimulated extensive inquiries into its causes. The social distress observed in the depression— unemployment rates above 25 percent and the contraction of real output by more than 30 percent—left an indelible impression on many of those who lived through it. As that population has dwindled over time, the social memory of the event faded and it was assumed that such an event could not happen in the world’s most advanced economy. Financial crises are runs on short-term debt— bank money. Through history, the runs have been on various forms of bank money, private banknotes and demand deposits, and then in 2007– 8 on short-term debt like sale and repurchase agreements (repo), various forms of commercial paper, and money market funds. All these forms of short-term debt issued by banks are money-like. They are used for transactions and as very short-term stores of
