The core logic behind my critique of macroeconomic stabilisation is that stability (and stabilisation) breeds systemic fragility. But this does not imply an opposition to all macroeconomic intervention, especially in a scenario when past stabilisation has left the macroeconomy in a fragile state. It simply insists on restricting our interventions to actions that preserve the essential adaptive character and creative destruction of our economic system.
A resilient framework of macroeconomic interventions must satisfy the following conditions:
- a focus on mitigating the most damaging consequences of disturbances on the macroeconomy rather than stamping out the disturbance at its source.
- a focus on discretionary interventions targeted at individuals rather than corporate limited-liability entities and limited to times of systemic crises.
- emphasis on maintaining general economic capacities and competences rather than protecting the specific incumbent entities that provide an economic function at any given point of time.
In theory monetary and fiscal policy interventions can easily fulfil all these criteria. In practise however, the history of both interventions is characterised by a systematic violation of all of them. The long history of propping up insolvent financial institutions via the TBTF guarantee and central bank ‘liquidity facilities’ combined with the doling out of fiscal favours to incumbent corporates has left us with a fragile and unequal economic system. As Michael Lewis puts it, we have “socialism for the capitalists and capitalism for everybody else” and the system shows no signs of changing despite the abysmal results so far. To paraphrase Robert Reich, behind every potential “resolution” of a debt crisis lies yet another bailout for the banks.
The pro-bailout proponents argue that there is no other option. According to them, allowing the banks to fail will bring about a certain economic collapse. In this post, I will argue against this notion that bank bailouts are inevitable and unavoidable. I will also lay out a coherent and simple alternative policy program to get us out of the mess that we’re currently in without having to undergo a systemic collapse to do so.
My policy proposal has three legs all of which need to be implemented simultaneously:
- Allow Failure: Allow insolvent banks and financialised corporations to fail.
- The Helicopter Drop: Institute a system of direct transfers to individuals (a helicopter drop) to mitigate the deflationary fallout from bank failure.
- Entry of New Banks: Allow fast-track approvals of new banks to restore banking capacity in the economy.
The argument against allowing bank and corporate failure is that it will trigger off a catastrophic deflationary collapse in the economy while at the same time crippling the lending capacity available to businesses and households. The helicopter drop of direct transfers helps prevent a deflationary collapse and the entry of new banks helps maintain lending capacity thus negating both concerns.
The Helicopter Drop
In order to promote system resilience and minimise moral hazard, any system of direct transfers must be directed only at individuals and it must be a discretionary policy tool utilised only to mitigate against the risk of systemic crises. The discretionary element is crucial as tail risk protection directed at individuals has minimal moral hazard implications if it is uncertain even to the slightest degree. Transfers must not be directed to corporate entities – even uncertain tail-risk protection provided to corporates will eventually be gamed. The critical difference between individuals and corporates in this regard is the ability of stockholders and creditors to spread their bets across corporate entities and ensure that failure of any one bet has only a limited impact on the individual investors’ finances. In an individual’s case, the risk of failure is by definition concentrated and the uncertain nature of the transfer will ensure that moral hazard implications are minimal. This conception of transfers as a macro-intervention tool is very different from ideas that assume constant, regular transfers or a steady safety net such as an income guarantee, job guarantee or a social credit.
Entry of New Banks
I have discussed in a previous post why entry of new banks allows us to preserve bank lending capacity without bailing out the incumbent banks. A similar idea has been laid out by David Merkel as a more resilient way to undertake TARP-like interventions. The fundamental principle is quite simple – system resilience refers to the ability to retain the same function while adapting to a disturbance. It does not imply that the function must be provided by the same incumbent entities. In fact, we are already beginning to see an expansion in non-bank credit as the era of low borrowing costs due to the implicit guarantee to bank creditors comes to an end. New banks unencumbered by the need to make up their past losses will be much better positioned to meet the credit demand from the real economy.The process of new firm entry in banking can be encouraged in many ways:
- Fast-track approvals
- Reduced capital requirements
- TARP-like seed capital participation as David Merkel has laid out.
Many commentators have criticised the ‘Occupy Wall Street’ movement for not having an agenda and a list of demands. But as Michael Lewis points out, their protests are not without merit. The slogan ‘We are the 99 percent’ captures the essence of the problem which is the explosion of the share of the national income captured by the richest 1% of the population. If this inequality was perceived to be fair or if it had occurred at a time of prosperity for the masses, it is unlikely that there would have been any protest at all. But as I have pointed out, the rise in income captured by the richest 1% is primarily driven by the rents captured by and through the financial sector. The same doctrine of macroeconomic stabilisation that acted as the source of these rents has also transformed the economy into a financialised and cronyist system unable to sustain a broad-based and sustainable recovery. Simply allowing the failure of insolvent banks and financialised corporations and putting an end to the flow of rents towards the banks will go a long way towards reducing the level of inequality in the economy. At the same time, the entry of new firms will restore the economy’s competitive and innovative dynamism.