Volume 10, Issue 4

The paradigm of self-stabilizing, equilibrating financial markets, respected for a long time, is seriously challenged by the recent financial crisis. Despite sophisticated bank risk management and comprehensive bank supervision interbank and corporate bond markets collapsed in 2007-2009. The state interventions required for saving banks are without precedent in modern economic history. In this essay we attempt to explain financial market instability. Key determinants of the crisis are, in our opinion, weaknesses of the information architecture which should provide credible information for investors. Three determinants of instability are identified: first, the utilization of debt instruments combined with high degrees of corporate leverage; second, the tradeability of securities combined with increased risk taking; and third, the increased degree of complexity of financial products and networks, combined with more homogeneous asset and risk structures of banks. These determinants strengthen financial system vulnerability and the role of the information architecture. We discuss several requirements for a meaningful regulatory reform, leaving out incentive issues (which are treated in Franke/Krahnen 2009), namely credible provision of information, macro-prudential supervision, robust capital standards, as well as a limitation of risk clustering in derivative markets.

Ill-designed regulation and inattentive supervision have contributed to the financial crisis, so has monetary policy. This article puts the focus on the European Central Bank (ECB). We test the hypothesis that the ECB’s change of concept in 2003 (money in the background) paved the way to follow the Fed’s overly expansionary monetary policy. We also discuss if policy should be geared to financial market stability. In contrast to the Greenspan-Bernanke-Mishkin view, some modest leaning against the bubble is supported. Finally, the ECB’s response to the crisis is evaluated. Cheap long-run jumbo loans and reduced security standards are potentially dangerous.

This article reviews the discretionary fiscal policy in Germany during the economic crisis of 2008/2009. After discussing the arguments for and against a fiscal stabilization program, I discuss several features a reasonable program should have. Applying those criteria to the German fiscal package, I find that while it satisfiesmost of them, it has two major flaws. First, the fiscal stimulus is likely to come too late, and second, the political marketing of the policy was disastrous. As a consequence the policy is likely to stabilize the economy in the second half of 2009 and in 2010, but did little to soften the initial blow of the recession.

In this article we analyse the role of International Financial Reporting Standards (IFRS) in the Financial Crisis. In detail we investigate if IFRS accounting rules and the change of some of their standards encouraged procyclical effects before and during the Financial Crisis.

Is the economic and financial crisis also a crisis of Economics? From different perspectives, today there is rather harsh criticism of Economics as a Social Science. In this article, first, some of the recent failures of Economics are discussed. Then some of the criticisms are taken up that are less convincing, in particular criticisms of the application of the economic model of behaviour, the mathematisation of Economics and the principle of value freedom. The appropriate role of the government as well as of competition is discussed, and also which other consequences should be drawn for Economics as a science but also for economic policy. Finally, we debate whether there is, besides the economic crisis, really a crisis of Economics as well.

One institutional peculiarity of the German health care system is the division of health insurance into public and private spheres. Another one is the financing of public insurance. Contribution payments are wage-related and shared between employers and employees. The article presents a blueprint for overcoming these peculiarities. The proposal is to substitute employers’ contributions by increased rates of the value-added tax. The employees’ contributions should be substituted by some combination of a flat premium and an adjustment of marginal income tax rates. Private health insurance should be constrained to supplemental coverage and it should phase out as far as basic coverage is concerned. Implications for equity and efficiency are discussed.