Financial crisis 2007: Market failure or Central planning mistake?

Financial Crisis

Financial Crisis

In the past years we have been reading that the financial crisis of 2007 was caused by the deregulation, avarice and the markets failures, and that these factors have occasioned the huge economic crisis we live nowadays. At least this is the official or accepted explanation. However, some of these elements are not even a cause of the problems we have in 2014.

In one of my previous articles I have analyzed the role played by the Central Banks in the Economy:

the importance and influence that Central Banks have in the world Economy are enormous: the decision regarding the production of currency notes determines the money supply (…). In addition, the money supply also determines the official interest rates; this rate has a huge effect on establishing how expensive or cheap the cost of making an investment is. In this regard, whether the Central Bank decided to lower the interest rates, automatically, the cost of financing an investment would decrease. So, these institutions may decide to turn on the credit tap or to dry it up, this power means, ultimately, to control the periods of economic expansion and downturn (…). If the interest rates are cut down, the Central Bank is turning the credit tap on, then, the cost of financing investments will decrease and all the private actors will start looking for the markets where they could get the highest returns. This economic expansion will not be backed up by private savings, but by the Central Bank.

If Central Banks may manipulate the interest rates to foster artificial economic expansions, then the current international crisis has been caused by these institutions. In 2001 the ECB and Fed decided to cut down the interest rates, as the economist Paul Krugman wrote “Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble”, and indeed it was done, the interest rates were decreased from 6% to 1% (Fed) and from 5% to 2% (ECB), the financial bubble fostered an international housing bubble between 2002 and 2008: an artificial economic expansion first, and downturn later. That is the effect of the intervention on the overregulated financial market.

If public institutions as the Central Banks are responsible of the financial bubble, the financial crisis cannot be caused by deregulation, avarice nor market failures. It has been caused by the mistake of central planned economy. On the contrary, a free market economy is based on a gold standard that does not let goverments (Central Banks) manipulate the money market, so the money supply and the interest rates do not depend on the decision of any central planning, but on the amount of gold in the Economy. In this situation, financial bubbles could not exist, as good and bad investment would not depend on whether the interest rates are cut down, so the information provided to the private agents would not be distorted.

That drives us to the following conclusion: if a free market economy would work on a gold standard instead of a planned money supply, and the international economy is based on the Central Banks, it is clear we do not live in a free market economy, but in a central planned economy, and then we cannot speak about any kind of failure on the financial market, but on a Central Banks failure.

Source| Money, Bank credit and Economic cycles, CEPR

Image| Financial Crisis

In WLT| Are the Central Banks a free market institution? The public money monopoly

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Legal Intern at Garrigues

Double degree on Law and Business Administration at Pablo de Olavide University.

Participant in Moot Madrid 2014 on International Commercial Law and International Arbitration.

Erasmus Programme at Nicolaus Copernicus University (Torun, Poland).

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