Current Crisis in the US and Economic Policy Implications

Abstract

The purpose of this contribution is to discuss the origins of the current crisis along with policy implications, concentrating on the US experience. The focus is on the emphasis given to financial liberalisation in the US, where great strides were seen in the development and extension of new forms of securitisation and use of derivatives — a practice which led to the growth of collateralised debt instruments, especially in the form of collateralised mortgages. The experience of the US with financial liberalisation is most telling in terms of the cause of the current crisis. However, financial liberalisation alone cannot fully explain the crisis. The size of the financial sector is also important. In this respect, it is important to note the enormous redistribution that had taken place in the countries at the centre of the crisis. For it was the case that a significant redistribution from wage earners to the financial sector had materialised prior to August 2007. That redistribution, along with the financial liberalisation alluded to above, led to the new financial architecture of collateralised instruments. These were the main causes of the crisis. But there were, we argue, contributory factors. We isolate two of them: the international imbalances, mainly due to the growth of China, and the monetary policy pursued by countries over the period leading to the crisis.