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  1. 1. Macroeconomic and Financial Policies before and after the Crisis Dr. S P Chaudhry (1213007) Ravindra Molo L (1213015) Srawan Kumar Agarwal (1213017)
  2. 2. Presentation Layout Content of this presentation is based on paper by Barry Eichengreen Financial Policies in Run-Up to the crisis Topic 1 Glass-Steagall and GSAs Topic 2 The role of Global imbamalnces Topic 3 Response Topic 4 Rethinking the Response Topic 5 Conclusion Topic 62
  4. 4. Root Cause lay in he United states Crisis has it root cause in the end of cold Market fundamentalism and policies flowing from it war- Greenspan Removal of Regulation Q ceiling on interest on deposits Rejected the proposal of regulating financial derrivatives Rise of China leading to Limiting the resources of SEC & other regulators global unbalance caused Banks were allowed to raise leverage to dangerous height crisis Privatization of supervisory and regulatory function Mortgage operator were allowed to raise subprime loans4
  5. 5. Poor banking practices The practices started due to inadequate regulatory resources Regulator allowed banks to If banks lacked models, rely on their own models to regulators allowed to use gauge risk and capital letter grades assigned to their adequacy. securities by the rating agencies. The rating agencies were no Banks had obvious incentive better. Advising an originator to tweak their models to limit on how to structure an the estimated likelihood of a instrument so as to secure an significant loss on their investment-grade rating and portfolios, since this limited the then rating the same security capital they had to hold and bred conflicts of interest. The elevated their profits. If it also agencies allowed themselves heightened the risk of failure, to be played off against one well, that was someone else’s another by issuers shopping problem. for ratings.5
  7. 7. Elimination of Glass-Steagall • elimination of the Glass-Steagall restrictions on mixing commercial and investment banking • not deposit-taking commercial banks freed up by the elimination of Glass-Steagall, that played the central role in originating and distributing complex mortgage- related securities, had the highest levels of leverage, and took the hardest fall • the removal of the Glass-Steagall restrictions intensified the competition between the commercial and investment bank7
  8. 8. US Policy to subsidise home loan • Freddie and Fannie were mandated to devote additional resources to low-income housing. • This political encouragement and the incentives it created, it is argued, fostered the growth of the subprime mortgage market at the epicenter of the crisis. • while policies channeling excessive finance into affordable housing did not help, a wider credit boom and more pervasive incentive problems were at work Political pressure mixed with financial innovation is a toxic brew8
  10. 10. Imbalance and Monitory Policy • Lower yield on treasury bond encouraged investors to stretch for yield by investing in risky markets • Large current account deficits • European banks were substantial enablers of the subprime crisis in the sense that they ended up holding large numbers of subprime-related structured credit products • U.S. monetary policy was too loose in 2003-4, it is alleged, when the Fed’s discount rate was significantly below the levels suggested by the Taylor Rule • But it is hard to imagine if yield would have been higher how it would have fundamentally changed the crisis10
  11. 11. Topic 4RESPONSE
  12. 12. Policy response • Policy response was quick and powerful • G 20 group felt need of coordinated efforts • Large fiscal stimulus by the US • Larger the slowdown more was the stimulus • Countries with high level of debt • central banks of countries suffering the most pronounced growth slowdowns had the greatest inclination to cut interest rates • countries cutting policy rates aggressively were not always rewarded with lower long-term real interest rates12
  14. 14. Policy response • the stimulus measures widely credited with averting “Great Depression 2.0” do not come off as looking quite so positive • governments should have been more aware of potential problems of debt sustainability and exercised more restraint in applying fiscal stimulus • Countries that entered the crisis with heavy debt loads should have been more cautious before undertaking additional deficit spending • the fiscal authorities should have done more to detail their exit strategies. • governments did too little to restructure and recapitalize banking systems • countries should have relied more on monetary easing and less on fiscal easing.21
  15. 15. Topic 6CONCLUSION
  16. 16. Final Take • while this crisis, like all crises, had multiple causes, at its center were problems of lax supervision and regulation, in the advanced countries in particular. It is appropriate therefore that post- crisis efforts in the United States and at the level of the G20 should focus on regulatory reform. • the crisis is a reminder of the value of keeping one’s fiscal powder dry • the crisis underscores the importance of early and concerted intervention to resolve banking-sector problems23
  17. 17. Final Take • the crisis reminds us that mechanisms for international policy coordination remain inadequate • the response to the crisis is a reminder of the importance of coordinating monetary and fiscal policies24
  18. 18. THANK YOU