Deal Wi' It and Move On

It’s easy to blame the government for a lot of things, and often rightly so. I guess the government is the most obvious link between the public and corporations who are affecting the state of the economy. However in recent times governments have little influence on how banks behave.  

It is government debt which will really affect the general public. In the aftermath of a market crash the government needs to get its debt under control. This involves raising taxes and reducing spending, both which affects the general public. It’s easy to see why people would point fingers at the government. So why do governments continually bail out banks which they know are in trouble? 

Governments generally bail out banks which get in trouble and run out of reserves generally because it is beneficial to the economy for them not to fail. In a forum paper Fama and McCormick (2009)* explains the theory behind government bailouts and explains why they are acceptable in modern macroeconomics. They say that there is an equilibrium between total global investments and saving which has to hold, however for any given country it is possible for investments and saving not to balance. Government policy will affect this equation and for a bailout to work it needs to satisfy the countries need for savings and investments. Problems with bailouts arises when the increase in government debt absorb potential funds for private investment, further hurting the economy.

Reinhart and Rogoff (2009)* highlight that following a major collapse, government debt skyrockets. This is part due to costs of bank bailouts and recapitalization, but more due to the collapse of tax revenue caused by the decrease in across the board spending i.e. the actions taken to reduce the effect of the crises are helping increase government debt.

In general government bailouts do not result in financial crisis. Crisis occur when bailouts are not managed well. This would suggest that politicians are to blame for financial crises. Gordon Brown took a lot of heat from his piers for the way he dealt with the 2007 crisis. Perhaps rightly so as he was the man with the power and the knowledge to do something about it but failed.

* Fama, E. & McCormick R.R. 2009, Bailouts and Stimulus Plans. Fama French Forum, University of Chicago.

*Reinhart, C.M. & Rogoff, K.S. 2009, The aftermath of financial crises.