The Global Financial Crisis

Abstract

This chapter describes how central bankers and other policymakers were lulled into complacency in the years leading up to the Global Financial Crisis of 2007–09 and analyzes the risks and vulnerabilities that were allowed to build up. Despite close surveillance by various actors and institutions, very few were drawing attention to the risks and gave timely warnings. However, the central banks fully raised to the challenge when the crisis erupted. Operating in uncharted territories and taking bold action to avert a meltdown of the international financial system, central banks became key responders in close collaboration with the IMF and G20. By introducing new and innovative policies, such as (sub) zero interest rates, unprecedented quantitative monetary easing and through strengthened international collaboration, including comprehensive currency swap arrangements, a meltdown of the financial system and a more severe and sustained economic depression were averted. However, the prolonged period of extremely low or negative policy interest rates may have contributed to misallocations of real resources, reduced potential output and led to unsustainable increases in some asset prices. With exits slow in coming, the monetary policy space to address possible future economic downturns and deflationary risks became limited. Concerns grew that central banks became overburdened and too often the only game in town to address growth. What was at first considered to be unconventional and exceptional temporary measures were to a large extent still prevailing more than a decade after the crisis erupted.