Keynesian and Fisherian solutions to current medical crisis0 pm

by HEMA SENANAYAKE-March 29, 2020, 7:30 pm
hemasenanayake@yahoo.com

The world learnt two lessons from the Great Depression in 1929-1933. One was provided by John Maynard Keynes in 1936. His General Theory evolved to dominate macroeconomics later with brief periods of setbacks. In a crisis like this suddenly all become Keynesians. The second lesson was provided in 1936 by Irving Fisher, a great American economist. He insisted that the economy must be founded upon Full Reserve Banking, as the Fractional Reserve Banking might lead to creating excessive debt bubbles which are bound to crash. He explained that the Great Depression was a direct outcome of Fractional Reserve Banking, which is known as the debt-based monetary system. Many economists agree that the Great Recession too resulted from the same debt-based monetary system.

We are in a mess. So think some economists. They say banks are solvent, this time around, unlike during the Great Recession in 2008-2009, when the crisis was complex requiring the government to bail out banks and major manufacturing companies. They further say that this time the problem is straightforward––the containment of the virus––while banks are solvent. This notion is wrong.

We are facing a full-blown crisis. It looks predominantly a health crisis and problem of a broken production and supply chain globally. But the crisis is much deeper. Stock markets are crashing. Values of pension funds invested in stock markets are depreciating. Investors in Asia and Europe move their investment funds to Wall Street, which would have resulted in increasing the Indexes at Wall Street under normal circumstances, but this time around those Indexes kept plunging, almost 30 percent down. Global savings just evaporating through Wall Street!

Is the banking system resilient to face the stock market crashes world-wide and absorb shocks arising from credit defaults by businesses and consumers? What about the possible sovereign debt defaults by countries like Italy? Already, banks are not making loans. A few days ago, Boeing asked for $60 billion from the U.S. Federal government. Watch what is happening in Goldman Sachs and perhaps you may gauge the level of resilience of banks from this single non-banking financial institution. I think US President Donald Trump should make a concerted effort with other world leaders to close stock markets temporarily until the curve of the disease infection is flattened.

If the crisis is a mess, then it is going to be a bigger and complex one which cannot be resolved by reduction of interest rates, Statutory Reserve Ratio and by another round of Quantitative Easing (a method of pumping money by the Central Bank). Paul Krugman, a Nobel Prize-winning economist has predicted that the world is drifting into a permanent recession. He might be right or wrong. But I think we must be prepared for the worst.

Still, Trump did not say that he was a Keynesian. But with his actions, he has proved that he is a Keynesian. He got both the Executive branch and the Legislature to intervene to manage demand and supply. Towards the end of last week, President Trump invoked a special piece of Legislative Act known as Defense Production Act. Under the powers of this Act, he (administration) asked General Motors (a car manufacturer) to manufacture respirators, and got another manufacturer of diapers to produce medical grade masks and protective gowns for healthcare providers. His government also asked alcohol beverage manufacturers to produce hand sanitisers, and the list goes on. In fact, he is now a super Keynesian. If the virus is contained successfully as we earnestly hope, there will be excess production of certain products but that’s no problem. There is nothing wrong if global leaders act like Keynesians. But to enable them to function as Keynesians, they need to act as Fisherians, too.

Obstruction of Global

production

It is true that the present obstruction of global production and supply chain and the resultant recession has not directly resulted from the debt-based monetary system.

Perhaps such recession could have been a few years away on the timeline.

Yet suddenly the world is facing a health crisis. I observe that Fisher’s proposition for the transition to Full Reserve Banking from the present debt-based monetary system is applicable under the current crisis, as the said transition could provide an opportunity to create a lot of debt-free money for governments to make their due response to the health crisis without creating any inflation.

What are the risks of such a transition? A few leading economists using mathematical models have tried to answer this question in recent times. Using Dynamic Stochastic General Equilibrium (DSGE) models, they have proved that the transition to Full Reserve Banking can be done smoothly. So should be the reversal of it, I think. Prof. Kaoru Yamaguchi is a leading Japanese economist who has studied this subject extensively after the Great Recession. Also, in 2012 the International Monetary Fund published a Working Paper in which it insisted that the above mentioned transition could be done smoothly. Research object of those studies was the US economy.

If the methodology is simplified, the Central Bank would increase the Statutory Reserve Ratio gradually to 100 percent. As a result, commercial banks will begin to function as intermediaries making loans without being able to create ‘credit-money’, a virtual money in the system. Hence, the virtual money formerly created by the commercial banks under Fractional Reserve Banking, would be created under a Public Money Policy by the Central Bank now. I think the plan could be implemented partially and might be reversed gradually when more flexibility is required for the economy, (as a new theory does not support a permanent transition to Full Reserve Banking system). Obviously, for those countries which use some other country’s domestic currency as their reserve currency for international payments, this plan could be prudent.

However, for those countries which hold global reserve currencies, like dollar and euro, this plan could be implemented partially so that those countries would create a lot of debt-free money to be used domestically or within the monetary union and to support the rest of the countries, while keeping enough flexibility to serve the world as reserve currencies.

Still American politicians are arguing about finding money. New York Mayor demanded money from the federal government, saying that many New Yorkers, who are not supposed to die, would die if the federal government did not act swiftly. The federal government was not quick to pass the stimulus Act, which will provide money directly to households, hospitals, cities, local and state governments. They do not think in terms of Fisher’s proposition, a method to create debt-free money. If physical capacity of production to face the health crisis exists, money should not be a limited resource. This is the time even the U.S. government must explore the possibility of switching from a debt-based monetary system to a partial "full reserve banking" system. By definition there is no partial full reserve system, but here partial full reserve banking system is a system in which commercial banks create a lower amount of "credit money" while the government creates a good amount of debt-free money under a Public Money Policy, not exceeding the system’s requirement.

Let us all be Keynesians and Fisherians to face this severe medical crisis.