Martin Wolf: How To Avoid the Next Financial Crisis: "The proximate explanations for the huge shortfalls in output were collapses in investment.... This weak investment must also help explain low rates of innovation, which is particularly visible in directly-hit countries. New technology is often embodied in new equipment...

...Countries that experienced banking crises suffered a four percentage point bigger loss in output by 2011-13 than ones that did not. Those with large pre-crisis macroeconomic imbalances, notably unsustainable current account deficits, also suffered relatively large losses. So did those with relatively inflexible labour markets. Again, those whose exports were more exposed to crisis-hit markets were hit harder. Countries that were more exposed to the global financial system also suffered larger losses. Lack of fiscal policy space proved costly, as well, as did a lack of exchange rate flexibility. The last is certainly an explanation, albeit not the only one, for the terribly poor performance of the eurozone.

The monetary actions taken by the high-income countries in the aftermath of the crisis have been controversial in many emerging markets. Many in high-income countries have also argued that the dramatic monetary easing was a mistake. Yet the evidence that output shortfalls are cumulative destroys the argument against strong and sustained policy support. However, stronger fiscal policy responses would have reduced the need for so long a period of unconventional monetary policies. Equally controversial were the capital injections and guarantees provided to the financial sector in the crisis. Maybe, ways could have been found to rescue banks without rescuing bankers. But the greater the support for the damaged financial sector, argues the WEO, the stronger the rebound. This evidence gives no support to “liquidationism”....

Three tasks and a lesson. 

  1. The first task is that of monetary policy normalisation in a world that has so much debt. Higher US policy rates have already revealed the vulnerability of a number of emerging economies. More turbulence seems highly likely.

  2. A second task is how to respond to another big recession, when the policy space is so diminished.

  1. The final task is coping with the political aftermath of the crisis. The decline in western credibility and relative power and the rise of demagogic forces are real, powerful and dangerous.

The lesson... big financial crises... once they have happened, it is too late. The analysis of regulation in the October Global Financial Stability Report suggests that we must ignore bankers’ bleating against regulation: above all we must keep capital requirements up. Recoveries could have been stronger with sustained fiscal and financial action, notably in the eurozone. But the costs of crisis would still have been high. “Never again” must be the watchword...