How governments respond to financial crises

Question 1

conventional monetary policy

Answer 1

expanding the money supply to lower interest rates and increase AD

this is sometimes not enough though

Question 2

lender of last resort

Answer 2

when falling confidence in banks leads to people withdrawing their deposits, the banks have less money to lend out

central banks can print money and lend it to the banks so that they do have money to lend (and AD doesn’t fall further)

this is only done to healthy banks

Question 3

conventional fiscal policy

Answer 3

cutting spending and raising taxes

however, government can incur large debts if they do too much of this (like in greece)

Question 4

injecting government funds

Answer 4

the government can inject capital (as in money) into failing banks and become the banks’ owner

this is basically nationalisation

there are also deposit insurance schemes where people who have deposited in a bank that has become insolvent are reimbursed by the government. this increases confidence

government intervention is controversial because it sends the message to banks that they will be bailed out if they behave recklessly

Question 5

subsidies to lending

Answer 5

banks that lend to firms and households are given subsidies