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Guiding Principles for Fighting Crises
The Panic of 2007– 8 was completely unexpected, to the enduring embarrassment of economists and regulators.1 There have been financial crises in the last thirty years, but they were in emerging economies. “[S]ince the 1980s emerging market economies . . . exhibit a long series of financial crises associated with major output collapse (for example, Argentina’s GDP fell almost 20% from the peak to trough in the 2001/2 ‘corralito’ crisis), those crises were easy to dismiss by the mainstream macroeconomist as stemming from institutional /political immaturity that will likely disappear once these economies embraced pro-market financial reform” (Calvo 2010, 1). As a result, not much is known about fighting crises because little attention was paid to the subject until the Panic of 2007– 8. Knowledge from previous crises has been forgotten. So, in 2007– 8 there was only Bagehot’s 1873 rule. In this chapter we propose some crisis-fighting principles based on the analysis in earlier chapters. What exactly is a crisis? A financial crisis arises when short-term debt becomes information-sensitive. The crisis is systemic. Short-term bank debt holders want their cash. The financial system is on the verge of collapse. Without a clear understanding of crises, they will recur. How can we get a clear understanding? History helps. The reason is that market economies have structural features that are always present, like the fact that demand curves slope down. Another structural feature is that market economies need short-term bank debt, but such debt is vulnerable to runs. Bank runs are likely to happen again because the form of bank debt changes and this can go unnoticed. Studying the clearinghouse responses to panics during the US National Banking Era is useful for getting a clear picture of what is going on during a crisis. Indeed, it provides a clear picture of what a crisis is and how to fight it. To be clear, we are not advocating a return
