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Instability in Financial Markets: Sources and Remedies The View from Economic History

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Taking a long‐run view from economic history, I make three points about instability in financial markets. First, I argue that economic historians have a relatively good understanding of the proximate causes of financial crises.

Crises are typically credit booms gone bust. A rapid increase in economy‐wide leverage is a powerful predictor of financial instability down the road. However, what role monetary policy, international capital flows, or moral hazard play in causing credit booms remains much less understood. Second, policy responses to financial instability, both monetary and fiscal, have become much more activist in the course of the 20th century. While this has helped cushion the fall‐out from financial crises to some degree, such policies have possibly contributed to the historically unprecedented build‐up in leverage during the second half of the 20th century. Finally, with regard to the debate about remedies, a historically informed view suggests a good dose of skepticism towards the policy frameworks that rely on assumptions about self‐ regulating and efficient financial markets.

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