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Tuesday, April 14, 2009

The Need to Monitor and Regulate Risk

I'm participating in this week's TPMCafe Bookclub:

Liaquat Ahamed joins us this week at Book Club for a discussion of Lords of Finance: The Bankers Who Broke The World. An economic history of the liquidity crisis from 1914 through the Great Depression, Ahamed focuses on four central bankers and their larger-than-life personalities: Montagu Norman of the Bank of England, Emile Moreau of Banque de France, Hjalmar Schacht of Reichsbank, and Benjamin Strong of the Federal Reserve Bank of New York. Lords of Finance details the four men's attempts to return the economy to the gold standard - and how a series of bad decisions brought the four major banks (and their respective economies) to the brink of collapse. ...

Joining the discussion are James Galbraith,... of ... the University of Texas at Austin; Sidney Blumenthal, former aide to President Clinton and Senior Fellow for the New York University Center on Law and Security; Julian Zelizer, Professor of History and Public Affairs at Princeton University; Randall Wray, Professor of Economics at the University of Missouri-Kansas City; Mark Thoma, Professor of Economics at the University of Oregon; and Nathan Newman, Policy Director for the Progressive Legislative Action Network.

Here's my first entry:

The Need to Monitor and Regulate Risk: At the end of his introductory essay, Liaquat Ahamed asks two questions. One is:

...has the structure of the economy changed so much ... that the traditional instruments of policy we thought we could rely on to jumpstart the economy will no longer work?

New approaches are required, but it's not so much the nature of the economy that has changed, it's that we forgot or never fully learned the lessons of the Great Depression.

One of the lessons of the Great Depression should have been that the financial authorities need to monitor and regulate excessive build-ups of systemic risk. In addition, once a crash occurs and fear is one of the main factors that is causing markets to freeze up, financial authorities need to know how to quickly reduce risk - they need some means of removing the questionable assets from the market place - and this must be done in a politically palatable, least cost manner.

The Fed can manage risk in two ways, through regulation and through the buying and selling of financial assets. For example, the Fed can use regulation to prevent firms from holding some types of risky assets, or to limit the amounts they can hold, and it can use things such as margin requirements to help to control leverage. Through open market operations, the Fed can trade safe assets such as Treasury Bills for risky assets, and in the process change the proportion of risky to non-risky assets held on the balance sheets of the public and private sectors.

I think policymakers failed on two counts. ...[...continue reading...] [Full discussion]

    Posted by on Tuesday, April 14, 2009 at 12:24 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (1)

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