Incredible Unstability of US Monetary Policy Origin of Global Financial Crisis: French University’s Professor of Economics

Azerbaijan, Baku, 20 October / Trend /

Pascal Salin, Professor of economics, University Paris-Dauphine, and former president of the Mont Pelerin Society provides special comments to Trend :

The IMF and the World Bank have not to be restructured, they have to be suppressed. Calls for restructuring and reinforcing the role of the IMF are particularly frequent nowadays because of the financial crisis. Many people claim that there is a need for a greater international cooperation and a world regulation of financial institutions. They consider that the financial crisis has demonstrated that the market was unable to adjust by itself, so that authorities must be responsible for stabilizing the financial sector; and, as the crisis is a world crisis, they consider that the answer has to be an international answer. Some people even dream of transforming the IMF into a world central bank. These views are radically wrong for one simple reason: The present crisis is mainly due not to the fundamental unstability of markets but, quite on the contrary, to the fundamental unstability produced by monetary authorities, more precisely by the US Federal reserve system.

Under the pretext of stimulating the economy, these monetary authorities embarked into a very expansionary monetary policy: The interest rate was decreased from 6,5 % in 2000 to 1 % in 2003 (and, later on, slowly raised back to 4,5% in 2006). During all this period of low interest rates, the world has been over-crowded with liquidity and banks just found superb opportunities to extend their credits and to make profits. They were the more inclined to do so that they could rightly make the guess that, in the case they would have problems, the state would bail them out (which appears now to be partially true).

Meanwhile, the US government developed a policy to induce financial institutions to take more risks, in particular in the financing of real estate. This is the real cause of the financial crisis: The incredible unstability of the monetary policy in the US has been at the root of the financial problems. On a market, with a lot of participants, if ever one firm or bank is making an error, it has a limited scope. But big governments make big errors and the bigger is the government the bigger can be the error. If ever we had a monetary policy designed - or, at least, coordinated - by the IMF for the whole world, we would have the risk of having the worst possible world unstability.

Moreover, the IMF and the World Bank provide resources to countries, either under the pretext of solving a so-called "balance of payments problem" or because they are assumed to have a need for external financing in order to stimulate growth. But world financial resources are scarce. Those which are distributed by the IMF and the world bank are no more available for other uses by responsible persons.

Given what we just recalled about the origin of the financial crisis - namely the fact that it has been caused mainly by public authorities and the incredible unstability of monetary policy - waiting for the G8 to cure the financial crisis looks like asking the pyromaniac to extinguish the fire. Meanwhile, as errors made by public officials are errors of great dimension, it seems that governments are the only institutions which have the necessary means to solve these huge problems. For instance they can rapidly organize a system of credit guarantee for banks (may be, by using the too easy way of expansionary monetary policies!). 

I have to admit that, given the economic situation and the present institutional arrangements, governments and central banks may play a role to help in the coming back of confidence into the credit system. But it would be better that a system a credit guarantee be organized by banks themselves, which would imply that they would also organize a system of mutual control. They would certainly have done it in the past if central banks and governments had not always more or less promised to play the role of "lenders of last resort".

In fact, what are governments able to do? They know how to increase taxes, to deprive people from their legitimate properties, to create new regulations, or to create too much money. But we do not need that. Due to the G8 intervention there is a risk: More financial institutions will be partially or totally nationalized, and more regulation will prevail. And there is also the risk that, in order to save some financial institutions or to try to stimulate the economy, too much money be issued, thus relaunching a new cycle of (illusory) growth in money and credit. It may give the feeling, in the short run, that the financial crisis is - at least partly - solved. But it creates a risk for the longer run by preventing the financial market from playing its stabilizing role and its role in the financing of growth in the world.

Now, what would be needed is twofold :

- Avoiding destabilizing monetary policies (at the limit, it would be necessary to prevent central banks from creating liquidities)

- Making possible for people to accumulate more voluntary savings, in particular under the form of equity capital, which is the foundation of responsibility.

In fact, a share-holder is responsible, since he knows that he will bear the consequences of what he is deciding, whereas a public authority is certainly more irresponsible: it does not get a loss from its bad decisions (as is exemplified by the fact that the Fed, as well as its former president and staff, do not suffer from the bad decisions they have taken in the past). Making possible for people to save more implies, in turn, a tax policy which would be less hostile to savings and capital accumulation than it is the case in most countries.

In fact, the great economic problem of our time comes from the fact monetary authorities have the power to create credits from nothing (just by creating money) so that a great part of investments all around the world are financed by illusions. And illusions cannot last for long, they end in crises. Financing through voluntary savings, in particular equity capital, rather than by credits based on an artificial creation of money, is the long run solution.

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