Given the enormity of the crisis, financial sector regulation is being tightened under the aegis of international bodies such as the BCBS and FSB. There are proposals that would raise the reserve requirement of banks. New regulations for liquidity requirements are also going to be in place. There are also proposals to require banks to hold government securities. Many of these measures are necessary.
5 However, the interaction of a persistent aggregate demand shock and inertia in the economy can considerably prolong the time for which the economy is in a state of excess demand pressure. Figure 4 illustrates this point by showing the response of an aggregate demand shock with a half-life of only two quarters in a stylised model of monetary policy with typical parameter settings.