Did Central Banks apply the right strategies after the financial crisis?

De Koning, Kees (2017): Did Central Banks apply the right strategies after the financial crisis?

Abstract

Nearly ten years have past since the last financial crisis occurred, making it easier to reflect on whether the policies applied by the Federal Reserve, the Bank of England and the ECB had the intended effect on restoring economic and financial stability.

While stability has in time been restored, it has not been restored for all. Was it a stability action plan for the banking sector, for the financial markets generally or for the collective of individual households?

This question matters as the possible solutions are quite different for each sector of an economy.

In a previous paper: “Why it makes economic sense to help the have-nots in times of a financial crisis” the author highlighted three interrelated issues. The first one was timing. In the U.S. a (mortgage) borrowers’ crisis occurred in 2003, when the income and house price gap forced new borrowers to accept an amount of a mortgage loan far exceeding their income earnings growth over the period 1996-2003. The second issue was the macro-economic volume of lending. Between 1996-2007 there was a strong correlation between the volume of mortgage lending and the increases in house prices in the U.S. – not wholly surprising. The third issue was that mortgage lending volumes were not kept in line with average income growth over the period 2000-2007, which had already from 2006, resulted in a rapidly increasing level of foreclosure filings, completed foreclosures and home repossessions. By 2007-2008 the resultant financial crisis had occurred.

In 2008, the threat to the banking sector forced central banks to come to their rescue.

The solutions chosen: Liquidity supply, Quantitative Easing, lowering of interest rates to historical lows, reform of banking supervision, and legal reform in the case of the U.S. in the shape of the Dodd-Frank Act.

The banking sector and the financial sector both benefitted from these measures. The collective of individual households did not. They were under tremendous pressure to pay back the mortgage loans, which the U.S. banking sector had so recklessly granted them. The lowest interest rates on record failed to entice them to borrow more.

This paper will look at what went wrong, what rescue measures were adopted and examining the position of the collective households and borrowers and will set out the difference between consumer price inflation and house price inflation. The first affects current incomes, the latter the debt position of households.

• Item Type: MPRA Paper
• Language: English
• Keywords: financial crisis,bank rescues, U.S. mortgage borrowing levels 1996-2016, median nominal income growth 1996-2016, the house price-income gap, liquidity support scheme for households
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

References

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• Statistic Brain Institute, Statistics on Foreclosure Filings, Completed Foreclosures and Home Repossessions 2004-2016, California, U.S.A.

• De Koning, Kees (2017), Why it makes economic sense to help the have-nots in times of a financial crisis, MPRA paper 82035, https://mpra.ub.uni-muenchen.de/82035/

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• De Koning, Kees (2017, February), How the Financial Crisis could have been averted, MPRA paper 77060 https://econpapers.repec.org/RePEc:pra:mprapa:77060