Distortionary effects of anti-crisis measures and how to limit them, DNB Occasional Studies
During the credit crisis, central banks and governments have taken extraordinary measures to preserve financial stability and prevent strong credit rationing of the private sector. Central banks cut official rates, provided liquidity support to the banking sector and supported specific financial markets with asset purchase programmes, whilst governments introduced measures such as guarantee schemes and made capital injections. These interventions prevented the financial system from collapsing and, in that sense, they have been effective. At the same time, the authorities have been aware that their measures may have distortionary effects on the markets. For instance, they may distort the level playing field between financial institutions that received support and those that did not, as is noticeable, for instance, from differences in funding costs. Furthermore, support aimed at specific market segments may lead to shifts in capital flows, and cross-border shifts may take place as a result of country-specific differences in support packages. Longer-term distortionary effects may follow, in particular, from excessive risk taking, e.g. by management, shareholders, bondholders and depositors of financial institutions. Such 'moral hazard' may also be created by extremely low policy rates and IMF measures. In designing their support measures, the authorities have sought to limit possible distortionary effects as much as possible. Thus, to the greatest possible extent, government support was granted on market-compatible and internationally harmonised conditions. Uncertainty among market participants may be mitigated by providing clarity on the details of the support policies, by creating an arm's length relationship between the government and the business management of the support-receiving institutions and by ensuring sustained responsibility on the part of private stakeholders. Of final importance is a smooth exit from support policies as soon as market recovery allows it.
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