Last year, the world’s central bankers and finance ministers were pulling out all the stops to save a crumbling financial system. A year later, it appears as though they have prevailed. However, only now are the true consequences of the crisis being revealed.

There’s no question that making policy on the fly is far from an ideal situation, but that’s what governments and monetary authorities were forced to do when confronted with the unprecedented financial crisis last year. At the time, there was a genuine fear of systemic failure; and many of the decisions were made under the threat of a complete meltdown.

With the benefit of hindsight, some of the moves made in the heat of battle may be judged harshly; but they can always be vindicated by the fact that the financial system didn’t fail. Still, notwithstanding this underlying justification, it is now apparent that governments and taxpayers will be living with the repercussions of those decisions for years to come.

Amid a snowballing crisis, the failure — and near-failure — of numerous large financial services institutions and the resulting economic fallout, policy-makers came up with a panoply of extreme measures last year. These included direct bailouts of financial services firms and capital injections; massive liquidity support measures and co-ordinated interest rate cuts by central banks; corresponding fiscal stimuli; a ban on short-selling financial stocks; and an easing of “fair value” accounting rules — all designed to keep both the financial system and the battered global economy afloat.

In some cases, the full extent of the government interventions is only now becoming known. In late November, for example, the Bank of England revealed that at the height of the crisis last year, it provided £62 billion in emergency funding to two of the country’s biggest banks, Royal Bank of Scotland and HBOS PLC. The Bank of England says it didn’t disclose this earlier to avoid causing a systemic disruption when markets were still under stress.

Similarly, in the U.S., the special inspector general for the Troubled Asset Relief Program has just revealed the results of its investigation into the controversial bailout of troubled insurance giant American International Group Inc. Among other things, it found that the Federal Reserve Bank of New York botched the rescue by: assuming private funding would be found; failing to prepare a back-up plan; implementing a fatally flawed bailout loan; and then failing to extract any concessions from counterparties to AIG’s huge derivative positions when the bank sought to unwind that portfolio, thereby delivering a “backdoor bailout” to these firms that resulted in tens of billions of dollars flowing to the firms from the government.

Moreover, the TARP report calls into question whether policy-makers also often invoked the threat of systemic damage to justify their actions. In particular, it points out that the U.S. Federal Reserve Board initially refused to disclose the names of the firms that had received the “backdoor bailout,” warning that it could undermine market stability.

Ultimately, the Fed bowed to congressional pressure, the report notes: “Notwithstanding the Federal Reserve’s warnings, the sky did not fall; there is no indication that AIG’s disclosure undermined the stability of AIG or the market.”

The basic lesson, the TARP report concludes, is that whenever public money is being used to support markets or particular firms, the public has the right to know what’s being done with that money.

More important than these latest revelations, however, is the likely long-term fallout from the major fiscal and monetary policy measures used to fight the financial crisis. Now, with the danger of systemic collapse seemingly past and the global economy apparently on the mend, economists are starting to deliver their verdicts on the policies that apparently staved off financial and economic calamity — although some experts still warn that we are not out of the woods yet, that a double-dip recession could yet occur or that equally deadly asset price bubbles are brewing.

The work of the central banks is at the heart of this debate. Along with their familiar interest rate-setting decisions, the central banks also embraced a variety of “unconventional” policy measures during the crisis, such as credit and quantitative easing.

“Central banks have been forced to … try out policies that, only a few years back, were not on their radar screens,” say a pair of economists with the Bank for International Settlementsin a recent paper, adding that “monetary policy will probably never be the same again.”

@page_break@Central bankers found themselves grasping for these new tools because simply cutting interest rates, by itself, wasn’t enough; but the track record of these unconventional policy measures appears to be mixed.

For instance, quantitative-easing measures haven’t worked as well as some had hoped. Although these programs have boosted banks’ reserves, this hasn’t translated into faster money-supply growth or increased lending to the private sector, suggests a research note from economists at Morgan Stanley Inc.: “The intermediate monetary objectives for [Britain] have not been achieved and recently broad monetary aggregates in the U.S. have been weakening. Much of the intended monetary expansion from [quantitative easing] was short-circuited by running into a banking liquidity trap.”

Nevertheless, the Morgan Stanley note insists that the experiment in quantitative easing should not be seen as a failure. Rather, it points out that these measures have helped to lower bond yields, rally risky assets and avoid a possible deflationary spiral. Ultimately, it suggests, these initiatives “probably played a significant part in the asset market recovery that, in turn, was essential in stabilizing the economy and preventing a second Great Depression. Perhaps, on this front, it is time to declare victory and prepare for withdrawal.”

The problem now is how to handle a retreat from these extraordinary measures. There are fears that if the central banks move too quickly, they may trigger a resurgent recession. Conversely, if they wait too long to withdraw their support, they risk inflating another bubble.

The BIS paper suggests that the bigger risk of the two is that central banks stay too accommodative for too long. The paper cautions that, with a tardy exit, central banks risk facilitating the buildup of financial imbalances, a resurgence of inflation and, at the micro level, creating a culture of corporate dependency — which, it says, “may weaken unnecessarily the ability of markets to work effectively without official support and may distort the level playing field.”

On top of this withdrawal dilemma, the new policy tools are also creating new challenges for bankers. “As central banks move away from the simplicity and well-rehearsed routine of interest rate policy, they face much trickier calibration and communication issues,” the BIS paper says, adding that central banks also risk compromising their independence from government and endangering their inflation-fighting credibility.

The central banks’ policy experiments aren’t the ones that have met with mixed success, and may have created more problems than they’ve solved. The finance ministers’ efforts to prop up economic growth with their own spending have the same potential. Ramping up government spending to spark economic growth certainly isn’t an unconventional policy tool. But questions about whether the stimulus is working and what the long-term side effects are likely to be are only now being tackled.

A new working paper from the International Monetary Fund examines the impact of the fiscal stimulus measures introduced by G20 countries over the past year and finds that although they are having a positive short-term impact, this may well be far outweighed by the long-run costs to government finances.

The paper indicates that the fiscal stimulus has provided a welcome boost to economic growth, particularly when combined with extremely loose monetary policy. But, in the long run, higher deficits, debt-to-gross domestic product ratios and debt-servicing costs will lead to higher taxes and interest rates and lower output. According to the IMF paper: “These output losses are larger than the corresponding short-run stimulus effects for the same instruments. But, much more important, they are also permanent.”

The IMF paper concludes that combined fiscal and monetary stimulus measures can help prop up economies during periods of acute stress, but that these measures need to be contained by a conservative, medium-term fiscal framework to keep the resulting deficits from spiralling: “In the absence of such a framework, the long-run costs would far exceed the short-run benefits.”

Although the crisis-driven decisions of central bankers and finance ministers appear to have been justified in the circumstances, it’s not as clear that the accompanying pressure to ease accounting rules is as defensible. During the crisis, many in the financial services industry blamed the effects of fair-value accounting for their woes — claiming that it helped throw fuel on the fire by forcing them to write down asset values too aggressively amid illiquid markets, thereby undermining their capital positions.

However, an examination of those claims by a pair of economists in a paper recently published by the National Bureau of Economic Research finds that blaming the accounting rules is not warranted: “Based on our analysis, it is unlikely that fair-value accounting added to the severity of the current financial crisis in a major way.

“While there may have been downward spirals or asset-fire sales in certain markets, we find little evidence that these effects are the result of fair-value accounting,” the paper adds. “We also find little support for claims that fair-value accounting leads to excessive write-downs of banks’ assets. If anything, empirical evidence to date points in the opposite direction, that is, toward overvaluation of bank assets.”

The NBER paper also argues that financial services institutions would hardly have been better off if they were using historical-cost accounting: “If anything, less transparency would have made matters worse.” IE