Preventing future crises


The idea that a sophisticated, financially liberalized country could enter crisis was unthinkable until the Great Recession. It will take some time before the academic understanding of financial crises catches up to this event. European countries that believed themselves to be integrated into the European Union, and therefore immune from sudden crises of confidence, experienced a psychological shock as they entered crises of their own and had to be bailed out by the International Monetary Fund (IMF). For once, developing countries watched as developed countries experienced economic degeneration.

That being said, contrary to what some people expected, a new economic superpower, such as China, did not arise. Much of the status quo in the financial architecture has been preserved. This only underscores the need for preventing future financial crises, as the Pandora’s Box of financial profit-seeking has been left open since the 1970s. Developing countries are still just as much at risk of experiencing the negative effects of shortterm capital outflows.

As James Galbraith (2008) puts forth, political economy itself has been at fault for allowing the causes of financial crisis, in the name of free markets and free trade, to arise. The current policy arena prevents proper crisis prevention policies from being put into place. Within this policy arena, he writes, “we see the grip of ‘free market economics’ on the public stage; to be taken seriously, one must be able to profess a belief in magic with a straight face.” The idea of constraining financial capital is not generally accepted. Galbraith shows that the Bretton Woods system of regulated exchange rates and capital controls allowed free trade to work. During this period, fixed exchange rates reduced uncertainty and low tariffs allowed more trade to occur. As discussed in Chapter 3, the Bretton Woods era certainly provided real and financial sector stability for some time. A similar, globally coordinated regime could improve economic stability. It is unlikely that a “New Bretton Woods” agreement will occur, however. Below, we discuss new financial crisis models and policies to prevent future crises.

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