Question

In this course we have considered five crises: the Great Depression, the Latin American Debt Crisis of the 1980s, the Asian Financial Crisis of 1997-99, the Subprime Crisis in the United States, and the Eurozone Crisis. This question asks you to describe the policy lessons that you can draw from these crises.

Let me be clear on what the term “policy lessons” means. We are thinking about government policies, mainly those of the Central Bank and the Finance Ministry (or Treasury Department). The question is: what should various government actors have done differently, to make the crisis less likely or less damaging?

Answer 1

The above case represents five major crisis that occurred globally which had profound impacts on the economic map of the globe. The Great depression of 1930’s was triggered by the stock exchange crash that occurred in the US in the late 1920’s which lead to serious issues like unemployment, production failures, huge inflation, decline in GDP etc which remained for almost 10 years and was brought to normalcy after Roosevelt introduced the ‘New Deal’ programme which gave strength to all the above sectors. The Latin American debt crisis refer to that stage which occurred in the Latin America in 1980’s when their foreign debt exceeded their earning power and they were not ale to pay it. The Latin American nations especially, Brazil, Mexico and Argentina borrowed huge credit from international creditors whose credit was mainly linked to the oil market instead of buying it from creditworthy lenders like the World Bank. The crisis was initiated when the global recession hit the world in the late 1970’s which caused a huge upsurge in the oil prices where the market failed and resulted in increased foreign debt of these nations. It had many effects which included an almost 20%-40% fall in real wages.

                                     The Asian financial crisis of 1997-1998 was initiated in Thailand when the Thai baht collapsed as the government was forced to float it due to lack of foreign currency to support its currency that had been pegged with the US dollar. It lead to the failure of Thai currency which was escalated to many East and South Asian nations. The Subprime mortgage crisis that originated in the US by 2006-07 lasted for a few years. It was initiated by a fall in housing prices that lead to devaluation of housing-related securities. The rise in sub prime lending and increased speculations of housing sector were the two major reasons that lead to the bursting of the housing bubble and resulted in the crisis. The Eurozone crisis was initiated by a balance of payment crisis which was caused by a sudden stop of foreign capital in to countries that had substantial deficits and were dependent on foreign lending. The debt accumulation was a major factor that aggravated the crisis.

                                    Once each of these crises are analysed at its depth it can be understood that all of them were avoidable or reducible crisis which were initiated and accelerated by indifferent policy decisions that affected the economic stability. The policy lessons that could be learned from each crisis is explained below.

· The Great depression was initiated by the stock exchange crash which was initiated by insufficient demand from the private sector and insufficient fiscal spending according to Keynesian theory and a money supply reduction that affected the confidence of investors that aggravated the issue according to the monetarist view. Thus it can be seen that if the policy making has ensured a better money supply by increased fiscal spending and better private participation, it would have helped to retain the investor confidence in the market and the sudden crash could have been avoided.

· The Latin American debt crisis was mainly aggravated when the international credit agencies were not able to cop up with falling oil prices. If the government had made borrowings from more stable financial institutions like the World Bank, it would have helped to maintain stability even at time of falling oil prices and such situations of rising foreign debt could have been avoided. Moreover, a free market capitalistic economy could have also reduced the effects, which was the action taken by the IMF after lending programmes were initiated.

· The Asian Financial crisis that originated due to failure of the Thai baht reminds the inefficiencies that would result in depending on pegged foreign exchange, Here the Thai baht was pegged to the US dollar which resulted in the failure of Thai currency and aggravated the issue. Thus, if the policy would have been based on floating exchange rates, the issue could have been avoided.

· The subprime mortgage crisis was initiated by fall of housing prices. This was caused by many policy changes hat were initiated in the previous years like decreased regulation of financial institutions, the repealing of Glass-Stegall act which separated the commercial and investment banks etc which paved the way for more spending for the mortgage sector and once the investor confidence was lost, resulted in the crisis. Thus optimal regulations in spending on mortgages with proper identifications of the beneficiary could have made better results.

· The Eurozone crisis is expected to have been caused by varying incentivization of the North and South Eurozone member nations which resulted in accumulation of debts in the South as the south was incentivized to borrowing. The lack of fiscal policy coordination among the eurozone member states and lack of credible commitments to bail out to banks also forms the reasons. Thus with increased fiscal coordination among the eurozone members, the ongoing crisis could be reduced.