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wp_crisislessons_091209

wp_crisislessons_091209

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Published by: Bruegel on May 18, 2011
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02/06/2013

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THE CRISIS: POLICYLESSONS ANDPOLICYCHALLENGES
AGNÈS BÉNASSY-QUÉRÉ*, BENOÎT COEURÉ**,PIERRE JACQUET
AND JEAN PISANI-FERRY
Highlights
There are three different, non-mutually exclusive lines of explanation for the crisis: wrong incentives in the financialsector, unsustainable macroeconomic outcomes, andmisunderstood and mismanaged systemic complexity.These yield different sets of policy recommendations.Steps have been taken to address several issues – overhaulof financial regulation, supervisory reform, changes in themonetary policy framework – but some crucial themes arestill to be addressed.On the regulatory front, moral hazard, separation of retailand investment banking, the desirable size of the financialinstitutions, and the impact of new capital regulations onthe cost of capital have to be resolved.On the macro-financial front, the crisis has shown thateconomic policy must encompass risk-management, andhas raised questions about the role of central banks infinancial stability. There is no agreement as to how muchcurrent-account imbalances contributed to financialinstability, and the history of peer-pressure-basedsurveillance does not bode well for the newly-created G-20framework for sustainable growth.Previously published as CEPII (
Centre d’études prospectives etd’informations internationales
) working document 2009-28.* CEPII, University Paris-Ouest and Ecole Polytechnique, Paris.** Ecole Polytechnique, Paris.ENPC, Paris, and Agence Française de Développement.Bruegel, Brussels, and University Paris-Dauphine.
    B    R    U    E    G    E    L    W    O    R    K    I    N    G    P    A    P    E    R
    2    0    0    9    /    0    6
DECEMBER 2009
 
2
 
T
ABLE OF CONTENTS
 Non-technical summary....................................................................................................................4Abstract ........................................................................................................................................5Introduction.......................................................................................................................................61. What went wrong?........................................................................................................................71.1. A brief account of the crisis.......................................................................................................71.2. Three questions on the crisis....................................................................................................111.3. A taxonomy of crisis theories...................................................................................................121.4. Micro roots...............................................................................................................................13a. Compensation practices..............................................................................................................14 b. Securitization..............................................................................................................................14c. Leverage.....................................................................................................................................16d. Market valuation........................................................................................................................20e. Why did the subprime crisis trigger a generalized panic?..........................................................221.5. Macro roots..............................................................................................................................24a. A failure of monetary policy?.....................................................................................................25 b. A consequence of global imbalances?.......................................................................................261.6. The “Black Swan” syndrome...................................................................................................291.7. Lessons.....................................................................................................................................312. Extraordinary times.....................................................................................................................322.1. Economic policy without the visual compass..........................................................................32a. The rescue of ailing banks..........................................................................................................32 b. Unconventional monetary policy...............................................................................................39c. Large-scale discretionary fiscal stimulus...................................................................................452.2. The aftermath...........................................................................................................................49a. Exit strategies.............................................................................................................................49 b. The legacy..................................................................................................................................502.3. Lessons.....................................................................................................................................543. In search of a new regime...........................................................................................................553.1. The financial system.................................................................................................................55
 
 a. Close the gaps in regulation.......................................................................................................55 b. Correct incentives ......................................................................................................................58c. Infrastructure and institutions.....................................................................................................59d. Organize macro-prudential supervision and regulation.............................................................603.2. The macroeconomic policy regime..........................................................................................61a. A new view on rules versus discretion?.....................................................................................61 b. International coordination and surveillance...............................................................................62c. Self-insurance or collective insurance?......................................................................................63Conclusion ......................................................................................................................................64a. The remaining regulatory challenge...........................................................................................64 b. Open macro-financial issues......................................................................................................65References ......................................................................................................................................67

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