Fail­ure of the Busi­ness Cy­cle The­ory and Call for a New The­ory*

China Economist - - Articles -

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

DOl: 10.19602/j.chi­nae­conomist.2017.04.05

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

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