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    Financial Crises: a Friedman-inspired solution

    Posted by Chicago Boyz on 29th May 2009 (All posts by )

    Guest Post by Robert Leeson (contact: rleeson at stanford.edu)

    Relentlessly printing and spending money may, with time, realign the self-interest of financial intermediaries with the social objective of lubricating our economic system. But by then we will be dancing with other demons: accelerating inflation and ballooning deficits. We must, therefore, attack financial instability at source by increasing the incentive to save and securing the channels by which savings are transformed into capital.

    Milton Friedman’s correspondence (which I am currently editing for publication) contains numerous references to the benefits of a consumed income tax relative to the existing tax on income. Friedman also favored restricting banks to deposit taking (and obliging banks to hold 100 percent of those deposits in liquid assets).

    Combining these two proposals produces a variety of structural reform possibilities – all of which would disburden capitalism of many finance-induced crises.

    Currently, the Federal Reserve influences interest rates (and thus, they hope, the economy) by buying and selling financial instruments (usually Treasury securities). The Fed could also create and sell new savings-into-capital instruments to initiate an investment-led recovery.

    A pre-tax savings vehicle could add to our capital stock on a dollar-for-dollar basis. These pre-tax dollars could be deposited with the Fed both through the withholding tax system and through supplementary contributions. These deposits should be inflation-protected and accessible to the saver at any time as income (minus provisional tax, which could be a declining function of the length of the deposit, tailing off to zero at, say, age 65).

    Read the rest of this entry »

    Posted in Economics & Finance | 1 Comment »