Munich Personal RePEc Archive

Are countries prepared for the next recession?

De Koning, Kees (2016): Are countries prepared for the next recession?

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Abstract

‘Act now on world turmoil’, says the International Monetary Fund in a recent speech by David Lipton , the watchdog’s second in command. The global economy is ‘clearly at a delicate juncture’ and the ‘risk of economic derailment has grown’. ‘A sharp retrenchment in trade is taking place’ as economies around the world have slowed down.

‘Credit boom shows signs of bursting’ warns the Bank for International Settlements. Global debts now stand at over 200% of GDP, exceeding levels seen before the financial crisis of 2007.

With warnings from these global institutions, it may be appropriate to raise the questions: ‘Are countries prepared for the next recession?’ ‘Are central banks equipped to deal with such recessions or have central banks used all their ammunition?’

The IMF was set up with a primary purpose to ensure stability in the system of exchange rates and international payments. It advises governments through its surveillance reports for its 188 member states and it has at its disposal about $1.2 trillion to help countries in financial difficulties. It is a government-to-government organization, acting as lender of last resort to governments, when needed.

The main objectives of central banks are external and internal. An external aim is to maintain stability of the currency against other currencies. The internal aim is to ensure that the value of the currency is maintained in purchasing power terms. Another internal aim is to supervise banks and act as lender of last resort for the banking sector, sometimes including non-banks operating in the financial sector, like pension funds. Finally some central banks have domestic economic objectives, like the aim to achieve a high level of employment.

In this institutional set up, there appears to be a missing link. Which institution has been or should be designated as lender of last resort to individual households? Privately owned banks cannot fulfill such role as their aim is to recover all money due when a loan facility is no longer serviced on time. Central banks cannot do it either, as their role is to supervise the banking sector. The U.S. experience as described by Dr. Bernanke in his book: ‘The Courage to Act’ was that no consensus could be reached over the manner of how to deal with foreclosure proceedings and home repossessions. In the U.S. over the period 2006-2013 21.3 million households, who faced foreclosure procedures, were left to their own devices and 5.8 million households paid the ultimate price in having their homes repossessed.

This paper will set out the case for establishing a new tool of economic policy: a National Mortgage Bank (NMB), to be used only as and when the collective of individual households acting as long-term borrowers see their financial position weakened due to the threats of a recession. The tool can both be used as a preventive instrument as well as a corrective one. Without its existence such actions cannot be taken. It will be the households’ equivalent of lender of last resort.

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