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Discussion Paper

No. 2010-1 | January 04, 2010
The Crisis and Beyond: Thinking Outside the Box

Abstract

In this paper the author attempts an analysis of the current financial/economic crisis that is wider ranging and more fundamental than he has been able to find. For this purpose he reviews some social science literature that views the current crisis as an episode in the secular decline of the United States and more generally of the Western Democracies. The timidity of current reforms, which is striking when compared to those that followed the excesses of the Gilded Age and the Great Depression, can be understood in this framework. The author discusses alternatives to the financial bailouts and shows how the crisis could have been dealt with more efficiently and at little cost to taxpayers. Finally, he discusses fundamental reforms that would greatly reduce the volatility of financial markets and increase their efficiency.

Paper submitted to the special issue
Managing Financial Instability in Capitalist Economies

JEL Classification

E31 E42 E58

Cite As

Claude Hillinger (2010). The Crisis and Beyond: Thinking Outside the Box. Economics Discussion Papers, No 2010-1, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2010-1

Assessment



Comments and Questions


Ralph Musgrave - Claude Hillinger's paper.
January 13, 2010 - 12:27

I would like to recommend Claude Hillinger’s paper. Hillinger deals with various aspects of the current recession, such as how best to treat failed banks, the toxic nature of Collateralised Debt Obligations, and the dishonesty and conflicts of interest involved in handing out stimulus money in the U.S.

One ...[more]

... of the ideas Hillinger promotes for helping to stop a recurrence of this economic disaster is full reserve banking. I have always been sympathetic towards this idea. And I discovered from this paper that Milton Friedman was in favour of full reserve banking. That was interesting (for me, anyway).

I think Hillinger is right to attack the widely held view that the only way (or best way) to obtain fresh money with which to stimulate economies in a recession is to borrow such money. As Hillinger rightly points out, new and additional money can perfectly well be printed.

Of course a certain amount of such money printing took place in 2009. But a significant proportion of those in power ( I would cite U.S. politicians in particular) have little idea what is going on “money printing wise”. Nor do they realise that a money supply expansion in a recession is a good idea (matched, when necessary, by a money supply contraction during a boom).

As regards failed banks, one option is for taxpayers to buy such banks’ toxic assets. I agree with Hillinger that this is wrong. The better alternative is to do what Sweden did with its problem banks in the 1990s. That is, failed banks should be nationalised and kept running with shareholders and creditors being wiped out (while ordinary households with small deposits are protected, of course). Having done that, the relevant banks can in some cases be sold back to the private sector with taxpayers making a profit in the process.

This may be problematic in the short term. But the “buying toxic assets” option just involves falling for moral hazard: it stokes up worse problems for the future.

It is always easy to criticise other peoples’ work. There is just one small point that would have strengthened Hillinger’s argument here (which I think was missing – though I might be wrong). Opponents of this bank nationalisation will probably claim that as soon as one bank is nationalised funds will flow into it because it will be seen as ultra safe.

This actually happened with Northern Rock and with Irish banks which during an earlier stage of the recession were given better guarantees by the Irish government that those given to British banks by the British government. The result was entirely predictable: large sums flowing Westwards across the Irish Sea!

This problem should be easily solved, for example by temporarily banning new deposits, or cutting interest paid by nationalised banks so as to keep deposits at a constant level pending return of the bank to the private sector.

Regarding money printing there was a passage in Hillinger’s section 4.4 I did not quite agree with. He said “Deficits financed with fresh money do lead to inflation. The important point in this connection is that as long as the money creation remains an episode that is terminated along with the deficit spending, the resulting inflation will also be episodic and will come to an end as the monetary impulse exhaust itself.”

I don’t agree that fresh money need cause inflation. The UK, for example, printed about an extra £200bn in 2009 (via a process which Hillinger correctly describes as a “charade”!). This is not proving inflationary yet. If and when it looks like being inflationary, we do not need to wait till the “episode has terminated”. This extra money can be reined in by the “government – central bank machine” raising interest rates and raising taxes so as to pay for the interest (and then doing nothing with the money so attracted). This effectively extinguishes the money (or at least some of it).

To put all that another way, Hillinger’s arguments on failed banks and money printing are stronger than as set out in his paper (at least in my opinion).

A full copy of Hillinger’s paper will remain on my computer for some time, and I will re-read it, or parts of it, with a view to picking up more ideas and pieces of information.


Claude Hillinger - response to Musgrave
January 13, 2010 - 14:04

I thank Ralph Musgrave for his thoughtful and informative comments. I want to make only a minor clarification regarding the inflationary consequences of money creation:

It is true that fresh money need not lead to inflation in the short run. The effects may require as long as a decade ...[more]

... to fully work themselves through the system. Of course, inflation need never occur if the new money is subsequently withdrawn. Howevewr, central banks don't know how to conduct a monetary policy that will stabilize the economy, rather than destabilizing it. I therefore think that it is better to allow the limited inflation of a one-time increase in the money supply rather than switching to a rstrictive policy that may chocke off the recovery.


Anonymous - Referee Report 1
February 02, 2010 - 10:39

see attached file


Claude Hillinger - Reply to Referee Report 1
February 08, 2010 - 09:19

see attached file


Steve Keen - Referee Report 2
February 19, 2010 - 14:27

See attached file


Claude Hillinger - Referee report
February 20, 2010 - 13:42

I thank Steve Keen for his sympathetic review and will be glad to incorporate his suggestions.