The current economic crisis is the result of an extraordinary period of extreme economic mismanagement. The world’s central banks, most importantly the Federal Reserve Board in the
They compounded this mistake by ignoring the explosive growth of credit and new complex derivative instruments. They allowed financial institutions to become hugely over-leveraged, ensuring that the collapse of the bubble would lead to major financial disruptions.
Finally, they failed to recognize the seriousness of the problem, understating the size of the problem at every step. This has slowed efforts to muster an adequate response to the situation. President Bush and other political leaders markedly worsened the situation when they raised the specter of the Great Depression and otherwise sought to raise fears in order to gain public support for the bank bailout package.
The meeting this weekend of the G-7 provides an extraordinary opportunity to begin the reversal of this dismal record. First, it is necessary to have a coordinated financial and monetary policy to stem the immediate financial crisis. This will require bank bailouts that focus on the direct injection of capital into the banking system, following the example of the
The financial system will also benefit from further cuts in overnight lending rates, especially by the European Central Bank (ECB). The ECB’s focus on concerns over inflation at this economic junction is almost as foolish and potentially more harmful than the decision to ignore the growth of the housing bubble.
The other key component of an economic recovery package should be a coordinated fiscal stimulus. In the
The stimulus should be designed to quickly boost demand. In the
It is possible that even larger boosts to spending may be necessary to restore normal economic activity. The federal government must be prepared to spend whatever amount is needed to keep the economy creating jobs. This was the main lesson that we learned from the Great Depression. Concerns over deficits prevented the government from taking sufficient measures to boost the economy out of its slump until World War II left the government no choice. It would be an enormous tragedy for the country and the world if the