How to respond to a financial crisis A number of different fiscal and monetary policy instruments were adopted in the aftermath of the 2008 financial crisis, as governments and central banks aimed to keep the cogs of the economy moving. We spoke to Professor Andreas Schabert about his work in assessing the effectiveness of these policy instruments. The financial crisis of 2008 posed an enormous challenge to governments and central banks across the world as several major financial institutions teetered on the edge of collapse, threatening to undermine the foundations of the global economy. Various different monetary and fiscal policy instruments are available to help maintain financial stability in these kinds of circumstances, a topic central to Professor Andreas Schabert’s research. “The main question in my project is; what monetary and fiscal policy instruments are particularly useful in times of crisis?” he outlines. Some of the instruments applied during and after the 2008 crisis had not been used before, so Professor Schabert believes it’s important to build a stronger evidence base. “For example, in 2008-9 the US Federal Reserve bought mortgage-backed securities (MBS) in large volumes,” he says.
Monetary and fiscal policy in times of crisis This project examines the effectiveness of unconventional and conventional monetary and fiscal policy measures that were conducted during the recent financial crisis. Examples are asset purchases and forward guidance conducted by the central bank or government spending programs. The project further examines financial regulation and the interaction with monetary policy. Professor Andreas Schabert University of Cologne Center of Macroeconomic Research AlbertusMagnus-Platz 50923 Cologne, Germany T: +49 172 2674482 E: schabert@wiso.uni-koeln.de W: https://cmr.uni-koeln.de/de/ team/senior-faculty/schabert/)
Andreas Schabert is a Professor of Economics at the Centre of Macroeconomic Research, part of the University of Cologne. His main research interests are monetary policy, fiscal policy, financial markets and international macroeconomics. He was a Duisenberg Fellow at the European Central Bank in 2014 and regularly contributes papers.
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Or are they doing even more harm?” he asks. Many economists think for example that the ECB’s interventions in European markets for government debt have been very helpful. “The ECB was successful in stabilising interest rates in accordance with its mandate, in particular for those countries which had before seen a very high interest rate premium on their debt,” explains Professor Schabert.
Fiscal policy Chart of development of central bank balance sheets over the period between January 2007 and approximately January 2014.
Monetary policy This was in response to concerns about the falling market price of MBS, a decline attributable to problems in the US mortgage debt market. This in turn led to problems for lenders, who re-financed by issuing these MBS. “When the price of these MBS slumped, re-financing of mortgage lenders became more and more critical,” explains Professor Schabert. The US Federal Reserve eventually stepped in and bought these MBS, and thereby stabilised the price. “In principle, this was a rescue instrument. The intention was to make sure that lenders could re-finance in a regular way,” continues Professor Schabert.
A variety of fiscal policy options are also available in times of crisis. One option is to increase spending to spur demand in the markets, so that overall production and income in the economy is stimulated. “That’s a traditional view on government spending,” says Professor Schabert. In the years following the financial crisis, many governments put in place huge spending programmes; the impact of this, considering the economic context, is a matter of debate. “Many economists have argued that these spending programmes are over-proportionally successful and helpful, when short-term rates are at the zero-lower bound (ZLB),” explains Professor Schabert. “In this context, the impact of monetary policy on the effectiveness of fiscal policy is overestimated, since longer-term rather than short-term rates are relevant for consumption and saving decisions.”
The main question in my project is; what monetary and fiscal policy instruments are particularly useful in times of crisis? “This was an exceptional measure, it had never been done before in the US and it has not been necessary since 2008, when prices stabilized.” The role of a central bank is traditionally thought to be supplying central bank money or changing money market interest rates, which have only indirect economic effects. When a central bank considers using a particular tool, such as an asset purchase programme, Professor Schabert says it’s important to consider how it will affect asset prices. “Are these types of interventions really helpful? Do they really support a market which is not functioning?
Further research in this area could underpin more effective financial regulation in future, while Professor Schabert hopes that the project’s work will lead to a wider acceptance of the need for interventions in financial markets. Over recent years new monetary and regulatory instruments have emerged, while the idea of macro-prudential regulation has also gained prominence. “We have to account for the economy-wide effects of regulation and the coordination of regulatory measures with monetary policy instruments. In the end, these policy tools jointly alter the conditions in various financial market segments,” says Professor Schabert.
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