Financial Crisis: Lessons from Different Management Approaches

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After the financial panic of September 2008 and the recession that followed, several of the key central banks of the mature, industrial world expanded their balance sheets aggressively, in what has become known as the era of quantitative easing (QE). Yet, there were major differences in the motivations and objectives of central banks for their QE programs, which led to very different approaches to their asset expansion practices. In turn, the different implementation methods resulted in very different outcomes, posing strikingly different challenges for their respective economies, with critical implications for future central bank policies. Our research compares and contrasts the activities of the Federal Reserve (Fed) and the European Central Bank (ECB). We come to relatively obvious as well as some potentially controversial conclusions, including the following:Quick and aggressive Fed and ECB actions after the bankruptcy of Lehman Brothers and badly managed bailout of AIG more than likely prevented another Great Depression.Later Fed QE programs adopted from 2011, even as the US economy was already recovering, may not have helped job creation at all.The ECB’s focus on liquidity loans calmed financial markets, but did not assist banks in shedding distressed assets and may have hindered economic growth compared to the Fed’s approach to purchase assets, reducing bank balance and capital requirements and leading to a faster economic recovery.The Fed’s exit from QE is likely to be highly complex, involving delays in returning to a more traditional short-term interest rate policy, diminished contributions to the US Treasury from central bank net earnings, and the potential for loss of some of the Fed’s independence over time as the US Congress increases its oversight concerning the size of the Fed’s balance sheet and potentially large unrealized portfolio losses.The ECB’s initial approach to QE, mostly through loans to the banking system, allowed for the easiest and most natural exit path among the major central banks – just let the loans mature.