Failure of the Business Cycle Theory and Call for a New Theory*
The US economy has emerged from the recent financial crisis and embarked on a path of recovery. A key response of the US government to the crisis was to restore the health of crisis-ridden financial institutions through direct fiscal relief and continuous quantitative easing and pumping sufficient liquidity into the financial markets. Fortunately, this process did not give rise to widely feared vicious inflation or post-crisis depression. Does this suggest that as long as the central bank offers unlimited loans or economic assistance to crisis-ridden entities to restore their health, a crisis can be averted? If this conclusion holds true, does this mean that the theory of cyclical economic crisis has failed? What is the new theoretical methodology to avoid economic crises? The answers to these questions will guide us in preventing and responding to financial or economic crises in the future.
economic crisis, monetary policy, cyclical crisis, quantitative easing JEL classification: E3; 05; G1
According to traditional theories, no country is exempt from the cycle of "crisis - recession- depression- recovery- boom - crisis again". Each recovery starts after a marketclearing process. Each recession erupts after the burst of bubbles. However, the US economic crisis in 2008 did not follow such a pattern. While the US economy appeared to be healthy before the crisis struck, most economists believed that a short-term recovery was unlikely after the eruption of the crisis. Yet instead of struggling with protracted recession and market clearing, the US economy swiftly recovered against all odds. An obvious fact is that the US government introduced a swathe of bailout and quantitative easing (QE) measures (see Table 1). The question for us is whether the central bank can overcome economic or financial crises with an unlimited easy supply of money and will a crisis be completely resolved through the regulatory policy of a monetary authority?
1. Federal Reserve's Intervention at All Costs: Preventing the Spread of Crisis
After the eruption of the US global financial crisis, former Fed Chairman Alan Greenspan testified before the House Committee on Oversight and Government Reform on October 23, 2008 that the credit tsunami was "once-ina- century" ( Greenspan, 2008), implying that the crisis was even more serious than the Great Depression of 1929. Later, he remarked to the effect that "theoretically speaking, monetary policy and market competition may resolve