The crisis brought about challenges to the fiscal and the monetary policy. The biggest reason is that the public and all other parties became over sensitive and could do everything to avert the possible of the repeat crisis such as the resent one. The initial actions that were taken to counter the bank crisis involved the review of the government expenditure, the taxation as well as the interest rate to counter the crisis. This was done in order to assist the economy to coup with the effects of the economic crises. The government expenditure was scaled down to what it could afford comfortably. The government also affected tax cuts to encourage spending the increase of the consumers’ purchasing power. The interests rates were also reviewed to enable consumers to repay their mortgages and reduce the effects of the banks crises.
Americans and other people think that the framework especially on the monetary policy that has been adopted cannot be able to control harsh financial crises. There are areas in which recent regulatory tools have shown weaknesses. One of the most notable limitations of this framework the inefficiencies experienced in graduating as well as applying micro-prudent policies in the capital requirements. Analysts argue that the framework has not been able to respond to the extent of the pressure that the balance sheets of the various lending institutions such as banks can endure.
The framework is also limited in terms of the choice of prudential regulation that can be achieved when calibrated. In addition, an aggregate advantage and sometimes the mismatch of maturity has been building up and are sometimes ignored. This has made the various regulatory requirements that have been set to be unsuccessful in some situations.
Banks have been driven through taxation as well as interest rates to all buy or sell at the same time. This creates homogeneity that is disastrous to the industry, which was designed to be heterogeneous. A heterogeneous system has an inherent ability to be resistant to various adverse factors in the industry. On the other hand, homogeneous systems have had many instances in which have lead to development of endogenous factors that have served to make it fragile.
Economic crises had terribly far reaching effects to the productivity of the whole economy. Indicators such as the GDP and the GNP demonstrate this exceptionally well. Banks experience large fiscal costs. Some countries experienced fiscal costs of up to 75% of the GDP. The output in the economy is experiences large losses and this affects adversely the operations of the banks to a point of warranting government intervention. The above reason caused the regulator to tighten all the system to avoiding any movement of the economy toward that direction.
There is stiff regulation through the fiscal policy to ensure that there is no monopolistic power in the industry. It is detrimental to prevent the occurrence of monopoly because of the economic importance it has. Monopoly should be sometimes encouraged; when achieved through innovation monopoly helps to come up with better products than the existing ones. Furthermore, the returns obtained through monopolistic power are useful as the monopoly gets enough fund ventures that are expensive, such include such as research; subsequently this leads to development of better products for consumers and all the other parties. Strict regulation can lock out this possibility especially when the regulator is overreacting to the previous experience.
One of the central pillars of the government regulation is the capital regulation. In the run up to 2007 crises, some banks had only around 2% of the balance sheet being composed of the banks’ asset. With limited liability, as well as investment of extremely little of their own money, this encourages extraordinarily reckless risk taking with no cushion against unexpected losses. The fiscal policy is directed to reduce this and attain well-calculated risk taking to avert any possible bank crisis in the future.
In conclusion, the government took various measures as the regulator of the banking industry. The action of the government occurred through the fiscal policy, which included taxation, government spending and the regulation of the interest rates by the central bank. The government took the above steps in order to reverse the effects of the banking crises, which had occurred through uncontrolled lending by the banks leading to increase of the members of the public defaulting. However, this government intervention has had some undesirable effects to the whole industry as it was discussed earlier. This is because it has come along with some undesirable effects that had not been projected.