Central Bankers Read Election Returns, Not Balance Sheets

Abstract

The financial crisis that began in 2007 has led to ad hoc actions to ‘save the banks’ in the United States, Britain, Ireland, and Iceland. The policy judgment has been that if the loan losses of the banks were much larger than their capital and they were closed with losses to the depositors, the economies would encounter massive deflationary pressures as the money supplies declined and as households and business firms became more cautious spenders. The governments felt the need to supply capital to banks to ensure that depositors would not take a ‘haircut.’ The provision of the capital was ad hoc, and then the policy makers realized that a new problem had developed as a result of partial government ownership of the banks.