The Hindu Business Line : Banks must lend, but can they be forced to?

In fact, Mr Michael Kalecki, a Polish economist and Keynes contemporary, attributed economic and business risk and cycles in market economies to variations in the consumption and investment behaviour of the capitalist class.

It is this source of instability that Keynes sought to address by making government spending a countervailing force to capitalist spending – going up when the latter fell to ensure that the economy did not slip into recession.

The fundamental characteristic of the current situation is the inability, reluctance and unwillingness of banks to lend to one another, businesses and consumers.

In short, they are confined to just nursing their losses, repairing balance sheets and rebuilding capital - a perfect recipe for a severe economic downturn. By themselves, the unlimited and unconditional liquidity and capital support of governments and central banks does little to prompt banks to return to the credit market – so badly have they been mauled.

This is the worry of the architects of the massive financial bailouts in the US, Europe and the UK. Love’s labour must not be lost.

If banks stay credit-shy, the rescue package becomes little more than salvaging banks’ shareholders’ from their disastrous losses – something that is unlikely to be countenanced by the general public.

So the problem is how to induce banks to lend. In the present macroeconomic environment, that is fraught with risk. There are already mutterings among bankers that they must put private shareholders’ interests in front even though they could not have survived but for governments and central banks. Will governments issue a diktat to lend?

The vital difference

In this respect, the present crisis differs from the Great Depression.

Then, it was beaten-down economies with few viable economic activities, unable to react to low interest rates – the so-called ‘liquidity trap’. The answer was government pump priming.

Today, economies are trending down with the significant risk of it exacerbating into a full –blown recession because of a possible breakdown of payments and settlements and credit crunch.

The expert on the Great Depression and current US Fed Chairman, Mr Ben Bernanke, must find new solutions and medicines, for the old ones will not work.

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