| The worldwide credit crisis that began with the | | | | slows down the economy too much, an economic |
| collapse of the housing market in the United States in | | | | recession can result, bringing financial turmoil and |
| 2008 was just one of many crises that central banks | | | | rampant unemployment. |
| and other financial authorities have had to deal with | | | | Central bankers, therefore, need to be prescient- and |
| during the first part of the 21st century. | | | | extremely careful- keeping one eye on inflation, |
| But the enormity of the 2008 financial collapse | | | | which is the product of an overheating economy, and |
| required government and central bank intervention | | | | one eye on unemployment, which is the product of a |
| never before seen in the global economy. After | | | | slowing economy. In the 21st century economy, |
| Lehman Brothers, one of America's biggest | | | | however, regulating money supply has become a |
| investment banks, was allowed to go bankrupt, the | | | | much more difficult task. With the amount of capital |
| Federal Reserve was required to bail out AIG, the | | | | flowing around the world dwarfing many countries' |
| world's largest insurance company. The $85 billion | | | | money supplies, it's almost impossible to know with |
| bailout was, until then, the biggest bailout in American | | | | certainty what the effect of any monetary decision |
| economic history. | | | | will have on a local economy-let alone on the world. |
| When banks began failing across the globe- primarily | | | | Inflation and unemployment have become the yin |
| because of bad investments in U.S. subprime | | | | and the yang of the 21st- century economy. When |
| securities, but also because of the freeze in interbank | | | | one rises, the other tends to fall. Although neither is |
| lending- it was clear that a full- blown worldwide crisis | | | | perceived as good, in recent years, inflation has |
| had arrived. Stock market declines of more than | | | | become the dominant preoccupation of economic |
| 50% in some countries presaged a global economic | | | | decision makers. It used to be that reports of a |
| meltdown. The concerted action of the world's | | | | surging economy brought euphoria to the markets. If |
| central banks, including the U.S. Federal Reserve, the | | | | factories and businesses were producing at full |
| Bank of England, the European Central Bank, and the | | | | capacity and everyone had a job, the markets would |
| Bank of Japan, helped calm things down for a while. | | | | greet the news with approval, confident that in a |
| But when countries began failing-Iceland and the | | | | booming economy, everyone would be better off. |
| Ukraine were the first of many national economies | | | | However, after the severe inflation scares of the |
| that had to be bailed out- it was clear that the fallout | | | | past decades, with prices rising out of control in |
| of the 2008 crisis would last for years to come. | | | | many countries, leaders realized that an economy |
| The key to finding the right solution to economic | | | | growing too quickly can be too much of a good thing. |
| crises is to somehow solve the immediate problem | | | | Reduced unemployment means that companies are |
| without making things worse in the future. Some say | | | | forced to pay higher wages for scarce workers, and |
| that the reaction of the Fed to the meltdown of the | | | | prices of goods and services need to be raised to |
| dot- com sector at the end of the 20th century- | | | | pay for the increased cost. |
| increased liquidity and drastically lower interest rates- | | | | In a booming economy, inflation can grow quickly as |
| set the stage for the meltdown of financial markets | | | | consumers and businesses begin to compete for |
| several years later, with massive defaults of | | | | increasingly scarce goods and services- and scarcity |
| mortgage holders who probably shouldn't have been | | | | leads to higher prices. The result is usually a vicious |
| given home loans to start with, but were lured in by | | | | circle of wage and price increases that end up hurting |
| artificially low interest rates. The result was a | | | | almost everyone- especially those on fixed incomes, |
| recession that was much worse than that which the | | | | who see their buying power decline when prices rise. |
| central bank was trying to avoid. | | | | The international markets watch each country's |
| Just as the speed of an engine is regulated by its | | | | inflation rate carefully- always on the lookout for |
| fuel supply, a country's economy is controlled by | | | | signs that an economy is stalling or overheating. |
| regulating its money supply- and each country's | | | | International investors, including gigantic pension |
| monetary policy is the responsibility of its central | | | | funds, hedge funds, and international banks, move |
| bank. In Britain, it's the Bank of England; in | | | | billions and sometime trillions of dollars, pounds, euros, |
| Switzerland, it's The Swiss National Bank; in the | | | | and yen around the world on any given day, looking |
| United States, it's the Federal Reserve; in the euro | | | | for the best return on their investment. When a |
| zone countries, it's the European Central Bank; and in | | | | country's economy looks like it is growing too |
| Japan, it's the Bank of Japan. These quasi- public | | | | strongly, and inflation is about to rear its ugly head, |
| institutions are set up by governments, but are then | | | | international investors can move their money out of |
| given the independence needed to keep an economy | | | | an economy at a moment's notice, preferring to |
| under control without undue interference from | | | | invest their funds in countries with more stable |
| dabbling politicians. Despite the tendency of the media | | | | economic growth and low inflation. |
| to concentrate on the latest economic statistic, there | | | | Just as a prudent driver keeps an eye on the road |
| is no one single indicator that tells us how fast an | | | | ahead, a country's central bank tries to keep the |
| economy is growing- or if that growth will lead to | | | | economy on a steady course. Central bankers need |
| inflation down the road. And, unfortunately, there is | | | | to look at all the economic data, such as factory |
| no way to know how quickly an economy will | | | | orders, housing starts, consumer credit, retail sales, |
| respond to changes in monetary policy. If a country's | | | | manufacturing, construction and employment |
| central bank allows the economy to expand too | | | | figures-some of which are leading and some of which |
| rapidly- by keeping too much money in circulation, for | | | | are lagging indicators-in an ongoing effort to keep the |
| example- it may cause "bubbles" and inflation. If it | | | | economy from overheating or sliding into recession. |