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Where to draw lines: stability versus efficiency

Economic Research Institute (82-2-759-5407) 2011.01.21 4412
Author : Thomas J. Sargent

What kinds of assets should financial intermediaries be permitted to hold? What kinds of liabilities should they be allowed to issue? Should a government or a central bank offer explicit deposit insurance or implicit deposit insurance by acting as a lender of last resort? This paper reviews how tensions involving stability versus efficiency and regulation versus laissez faire have for centuries run through macroeconomic analysis of these questions.

1. Introduction 1

2. Efficiency versus stability 4

3. The real bills doctrine 5

3.1 Criticism of real bills doctrine 6

3.2 Indeterminacy under real bills? 7

3.3 Real bills partly rehabilitated by Tobin 8

3.4 Real bills rehabilitated in general equilibrium 9

3.5 Real bills versus the quantity theory, or efficiency versus stability 10

3.5.1 Fluctuations ignited by fundamentals 10

3.5.2 Fluctuations coming from sunspots 13

4. The Chicago plan for 100% reserves and Milton Friedman's

improvements 14

4.1 General equilibrium analysis of Friedman’'s improvements 15

4.2 Indeterminacy theme 16

4.3 Paying interest on reserves subverts independence of the central bank

and the fiscal authority 17

4.4 Take away points 17

5. Another line: fighting bank runs versus discouraging excess risk-taking


5.1 Deposit insurance is good 19

5.2 Deposit insurance is bad 20

5.3 Aligning political incentives 22

5.4 A model with good and bad aspects of bank bailouts 23

5.5 Related approaches 25

6. Concluding remarks: what is a real bill? 25

Appendix A Bagehot: ideal versus practical banking regimes 28

Appendix B The real bills doctrine 29