Need for new macro-economic policies: In the backdrop of financial crisis

Abstract

The recent sub-prime crisis brought the financial system to the verge of collapse. Central banks world over had to intervene in order to avert a financial catastrophe. Economists all over the world are divided in their views regarding the main causes of the crisis and the changes required to reduce the probability of such a crisis in the future. This project looks into various facets of the financial crisis. It attempts to answer the question whether elements of monetary policy can be used to achieve financial stability. The link between monetary policy and financial stability is studied and the fallacies in the traditional measures to bring about financial stability are identified. We look into various factors such as financial deregulation, financial innovation that lay at the heart of the crisis and the role played by the regulations in the crisis. Also, there appears to be a strong correlation between asset prices booms, credit booms and the probability of recession. We analyse various policy options that are available and look at empirical proofs to judge the effectiveness of these policies. We attempt to analyse the factors that that led to the build-up of unsustainable pressures before the crisis and the factors that play a role in the repetition of financial instabilities. Relevant regulations such as Basel norms and Dodd Frank Act are analysed in this report. Finally we give various measures and suggestions that can identify and prevent such financial crisis from recurring in the future.