Innovations and Monetary Control THE U.S. financial system has changed greatly in the past twenty years and will unquestionably continue to evolve in response to challenges and opportunities. In this paper I survey a number of important innovations that have occurred in an attempt to understand the forces that led to change and the consequences the innovations have for the future conduct of monetary policy. As will be seen, each of the innovations is itself a response to conditions that existed in money and capital markets on some date. Indeed, it can be claimed that each innovation was induced by monetary policy decisions that were taken before that date. Individually and collectively the innovations probably have had an expansive effect on the economy, because it is likely that each led to a decline in the required rate of return for holding capital.' The new financial instruments and institutions are competing successfully with assets, Research support from a National Science Foundation grant is gratefully acknowledged. I am indebted to Andrew S. Carron and Stephen M. Goldfeld for their comments, which led to several improvements. I also want to thank the other members of the Brookings panel for a number of constructive suggestions. 1. The issue, as usual, hinges upon whether all assets in the private sector's portfolio are gross substitutes. The innovations considered in this paper have tended to nullify regulatory interferences such as reserve requirements and interest rate ceilings on deposits. In the absence of such regulatory interferences, the assumption of gross substitutability leads to the prediction in the text. See James Tobin and William C. Brainard, "Financial Intermediaries and the Effectiveness of Monetary Controls,"
Crisis: Causes and Solutions FOR THE SECOND TIME this decade, the thrift industry is in crisis. Once again thrift industry performance is deteriorating, failures are widespread, the regulators are besieged, and Congress has passed major banking legislation following protracted debate. Indeed, the current difficulties will be harder and more costly to resolve than those of the early 1980s. The implications-for competition in financial services, availability of funds for housing, and federal budget expenditures-are profound. We begin our paper with a review of the thrifts' difficulties, from signs of trouble in the 1970s to the contemporary attempts to shore up the deposit insurance fund. In doing so, we show how regulatory forbearance during the early 1980s turned an initial crisis, caused by the thrift industry's undiversified portfolio of fixed-rate, long-term mortgages, into a near-disaster, in which hundreds of insolvent thrifts continue to operate. We assess the policy response to the current crisis and make recommendations of our own. Finally, we show how the recently deregulated thrift industry has been diversifying and moving away from its traditional role. We also discuss the outlook for the thrift industry in the context of regulatory reform, innovation, and competition. We would like to thank the members of the Brookings Panel and James Barth for helpful comments on an earlier draft.
THE THREAT of a "financial crisis" may have motivated the Federal Reserve Board's apparent decision to relax monetary policy earlier this year. Such crises have been a recurrent theme since the mid-1960s, although definition of the term and prediction of the event have proved equally elusive. Corporate bankruptcies, failures in the thrift industry, problems at regional banks, and near-defaults on loans to foreign borrowers have created new concerns about the resiliency of the financial structure. The concerns are especially great because of the linkages between the health of the financial system and the growth of real economic activity. In this paper I propose to differentiate between the ebb and flow of the business cycle on the one hand, and events triggered by financial market weaknesses on the other. In that context, I evaluate recent experience in domestic and international financial markets. My conclusion is that the current episode qualifies as a full-fledged crisis of a magnitude comparable to the 1974-75 experience. The Federal Reserve is seen to play crucial roles both in the development and in the resolution of past and present crises. Definition Analysts have used the term "financial crisis" (or a variant such as "liquidity crisis") to describe a variety of phenomena differing primarily in the degree of distress that is implied. Hyman Minsky has emphasized I thank Ralph C. Bryant and the Brookings Panel for helpful comments. I also thank Judith D. Kleinman for research assistance and Kathleen Elliott Yinug for secretarial assistance. The research on thrift institutions presented here was supported, in part, by a grant from the Federal Home Loan Bank Board.
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