This blog is aims to express my opinion about the role of central bank in financial crisis. And measures central banking should take to avoid financial crisis.
No matter the Great Depreciation in the 85 years ago or the global financial crisis recently happened. Central bank take an important role during it. With the development of the financial innovations and the derivatives productions. The supervision ability of central bank should be improve. Also, the cooperation is especially important. In the Great Depreciation, there is no cooperating between countries but we can see from this global financial crisis. Cooperation can help other countries pass the crisis e.g. Iceland financial crisis. Because of Economic Integration need the countries all over the world to cooperation.
Further thinking:
Despite the world economic situation now get better, but what should central bank do to avoid financial crisis in the future is a question we should consider. In my opinion, the attitude is an important factor. It conclude the attitude central bank towards entire economy and the consumer towards consumption. I will think about it in the future.
Last blog I talked about the central bank response to the global financial crisis from developed countries. In fact, not only in the developed countries, developing countries also suffer from the global financial crisis and take measures after global financial crisis like China.
Although in recent years Chinese economy had a booming increased and became the become the world's second largest economy behind U.S. But we can easily see from the graph of Chinese GDP growth change percent. It has a sharply jump from the financial crisis happened.
Graph 1: China GDP growth (annual %)
Chinese central bank hold few subprime bonds and foreign exchange reserves held in the form of U.S. Treasury bonds, so the financial effect to China is not strong like other countries. But exports are the one of most important part to Chinese economy, when the global financial crisis happened, the exports of China suffer serious damage.
Graph 2: China Exports
For Chinese central bank, there are not so many financial derivatives production to supervise, and the People's bank of China has strong power to control the commercial banks and economy. In one hand, Chinese central bank raised the reserve ratio 15 consecutive times from 9% to 17.5% between 5.1.2007 to 7.6.2008. It is for increasing balance sheet of reserves of banks and decreasing the inflation. After that, central bank decrease the reserve ratio through political regulation to increase the money supply. On the other hand, government through central bank issues the four trillion yuan investment project. The methods combine open market operation and political regulation I think it is good for economy. For the developing countries which market level not high as developed countries is a good choice to meet the financial crisis.
Next blog I will give the conclusion and some further thinking about central bank.
In last blog, I mentioned in Larry Elliott's article, the global financial crisis been divided into five key stages. Different from the others financial crisis in the past. The government and central bank all over the world react quickly.
In the U.S., the Emergency Economic Stabilization Act of 2008 published in the 3.10.2008 after Lehman Brothers filed for bankrupt.Including the Government has allocated seven hundred billion U.S. dollars to buy illiquid securities secured by real estate, the purpose is to increase the liquidity of the secondary mortgage market and reduce losses of financial institutions have these securities may be facing. After that Federal reserve through Quantitative easing policy to increase amount of money supply. In Obama government, they made a number of new solutions and continued the QE policy. In 31.12.2012, Federal reserve system released the QE4 said that Monthly purchasing $ 45 billion debt to replace operation twist, QE3 per month plus $ 40 billion of the amount of easing, the Federal asset purchases to reach $ 85 billion per month. In addition to quantitative easing drastic than the Federal to maintain a zero interest rate policy to keep interest rates at 0 to 0.25 percent of the very low levels.
Graph 1: Money supply of Unite State from 1998 to 2012
Similar to the policy of U.S central bank, the central bank in most developed countries also choose to inject money supply. In Europe, the European Central bank also issue a series methods to meet the financial crisis. The key point is also to print money into the market. France, Belgium and Luxembourg, the three governments to provide 9 billion euros in Dexia Group. After the Irish banks are affected, the Irish government announced six Irish banks including Allied Irish Bank, Bank of Ireland, British Irish Bank, Irish Life Permanent, Irish Nationwide and EBS Building Society to guarantee all deposits, including bonds, senior debt and dated subordinated debt, involving a debt of about 400 billion U.S. dollars.
This blog I talk about the methods central bank take to meet the global financial crisis in developed countries. Next blog I will focus on the developing countries behavior.
Data:
The graph collected from http://www.quandl.com/
After the Great Depression, people realized the economy should not develop restrict. Central bank are more and more important to help the market healthy. Central bank gradually found many economic ways to control the economy like open market operations and discounted lending. The recent global financial crisis is the worst financial crisis since the Great Depression which started from 2007 and many people believe it still be continued.
This is a simple but clear video to explain why global financial crisis happen. In fact, the global financial crisis not only included reasons in this video but also have many factors. In my opinion, the over-development of credit and derivatives are the most important factors in this financial crisis. And the weak power that central bank in these new areas is the core.
First of all, after a series financial crisis, central bank from all over the world enhance their ability to manage the economy through policy and market operations. But in the 21th century, with the development of Internet and new financial productions. Credit and subprime mortgages are the potential risk but central bank did not found a proper tool to control it until crisis happened. Secondly, high leverage led to investors invested blind. For example, asset-backed security make poor credit security into market. Finally United States of deficit fiscal policy, high-spending policies and export control policies mean such virtual channels, include physical resources (natural resources, labor and capital resources) around the world are pouring into the United States. It will harm to the economy all around the world. This is my idea about the reason of global financial crisis from the central bank.
In Larry Elliott's article, he divided global financial crisis into 5 key stages. So I will think about the central bank's measures during the global financial crisis.
Data
The video collected from http://www.youtube.com
In last blog I talk about the damage and the reasons for central bank factors to caused the Great Depression. This blog will research on the measures took by US central bank and the effects.
The New Deal was a series measures enacted in the US from 1933 to 1938. It not only focus on the real economy, but also adjusted the virtual economy. The new regulations issues from central bank are important in the New Deal. The three cores of the New Deal is Relief, Recovery and Reform.
At the third day of Franklin Rooseveltbecame a president, he declared that domestic commercial banks go "bank holiday". Then proclaimed Emergency Banking Act in 9th March. The Federal created insurance for the healthy banks. Examined the bank's balance and issue permit for these healthy banks. The Federal insured that reopened banks would be sage. In the 16th June, US passed the 1933 Banking Act for establishing Federal responsibility borne by the Federal Reserve System. The separation of investment banks and commercial banks, to prevent banks from using depositors funds speculation, also provides for the establishment of the Federal Deposit Insurance Corporation, the implementation of insurance for small deposits. At the same time Federal Reserve Bank issued notes to save money shortage, authorize Reconstruction Finance Company to purchase preferred stock banks to provide liquidity to the National Bank, Ministry of Finance authorized the bank to rectify and funding, and to prohibit the storage and export of gold. The series measures are central bank use regulations to resolve financial crisis.
As a consequence, the New Deal got a positive effects for American economy, especially in finance area. The number of unemployment rate has significant decrease after the New Deal. And the USA real GDP have a huge increase.
In conclusion, through the crisis explanation and the facts. Commercial bank is unstable and it need central bank to control or hold the system's reserves. In my opinion, the Great Depression and the New Deal are the first time let people understand how important of central bank. But it is just the basic function of central bank. In the recent few times financial crisis, we found many new problem and new functions for central bank. I will think it critically in following blog.
Data:
The video collected from http://www.youtube.com
The graph collected from http://en.wikipedia.org/wiki/File:US_GDP_10-60.jpg http://en.wikipedia.org/wiki/File:US_Unemployment_1910-1960.gif
Conference
1. Hickson, C. and Turner, J. (2004) Free Banking and the Stability of Early Joint-stock Banking, Cambridge Journal of Economics. 28 (6), 6, p. 903-919
2. Arthur Meier Schlesinger, Jr. The Coming of the New Deal, Houghton Mifflin Book (2003), p. 115
The Great Depression is one of most serious financial crisis in the history. The Great Depression start from the United States, then swept the entire capitalist world, the formation of an unprecedented, sustained the longest in the world economic crisis. Many scholars explained it from different angles. Today, I am focus on the role of central bank in the Great Depression.
In the Panic of 1907, due to without central bank, it caused pervasive USA economic recession and bank failures. After that, the government created Federal Reserve System (FED) as American central bank in 1913. Although FED had established, the US government believed "Invisible-hand" will control the market. The graph 1 shows the US real GDP booming from 1920 to 1929. But after a brief economic boom, crazy stock investment finally led to the dreaded "Black Thursday" and triggered financial crisis. In my opinion, the negative effects of central bank are important in the Great Depression.
Graph 1: US real GDP from 1920 to 1929
First of all, there was no deposit insurance system. Commercial banks do not have deposit reserves in the central bank, when the bank run happen. It will cause bankrupt and lose trust from savers. Central bank did not established an effective deposit insurance for avoid bankrupt. Secondly, central bank have no regulation about the credit consumption. As we can see the graph 2, the growth of S&Pstock index are much higher than the GDP increase. When economic crisis broke out, the monetary credit suddenly tightening, led to currency credit crisis.
Graph 2: US annualized growth rate from 1920 to 1929
Thirdly, effective macroeconomic management has not been established, central bank have no idea about economic adjustment, which led to a serious loss of control. Last but not least, the FED did not created regulation to supervise security market. Over-expansion securities market means bubbles.
In conclusion, central bank is an important factor of financial crisis. For the healthy economy, the economy should not only control by the market, but also need government macroeconomic management like central bank regulation. In fact, because of macro-control policies, the United States smoothly through the Great Depression. I will analyse it in the future blog.
