What has been shown globally not to work to end a bank solvency led financial crisis can be summarized as either zero interest rates/quantitative easing with fiscal stimulus or zero interest rates/quantitative easing with austerity.
Your humble blogger predicted before these policies were implemented that they would not work. I have explained in detail why they would not work and why they have not work.
Fortunately, there is a policy that has proven it ends a bank solvency led financial crisis and restores economic growth. I call that policy the Swedish Model.
Under the Swedish Model, banks are required to recognize upfront the losses on all the excess debt in the financial system. This protects the real economy and allows it to continue to grow.
Why does the Swedish Model work?
The Swedish Model protects the real economy by not diverting capital that is needed for reinvestment and growth to debt service. Unlike the policies that have been adopted to date, the Swedish Model doesn't place the burden of servicing the excess debt on the real economy and then try to boost demand to offset this loss of capital through monetary and/or fiscal stimulus.
The Swedish Model also uses the banks as they are designed to be used. Because of deposit guarantees and access to central bank funding, banks are capable of operating and supporting the real economy even when they have low or negative book capital levels. Banks can do this because the deposit guarantee effectively makes the taxpayers the silent equity partner of the banks when they are in book capital rebuilding mode.
Where has the Swedish Model been used and shown to work?
In the US, the Swedish Model was implemented during the Great Depression beginning with the 1933 bank holiday. As the NY Fed said, it broke the back of the Great Depression.
In Sweden, it was used during the 1990s.
Finally, it was used by Iceland at the beginning of our current financial crisis.
Given this track record, why hasn't the economic profession endorsed it?
Thanks to Nobel prize winning economist Joseph Stiglitz we know the answer. Prior to the current financial crisis, economic models treated the banking system as simply moving money from one pocket to another. Therefore, there was limited reason to study banks or include them in models used to predict economic performance.
If you are not studying the key element in the policy that has been shown to end bank solvency led financial crises, you are not very likely to endorse this policy.
Why should policymakers adopt the Swedish Model now?
Because it is clear to everyone that the economic policies adopted to date have failed. If they had remotely worked, central bank balance sheets would be contracting rather than growing exponentially.
All the alternatives recommended by the economics profession have failed.
On top of this, the economics profession through Reinhart and Rogoff has been discredited as a serious science. Economists have been revealed as simply biased story tellers whose stories are most likely based in pure fantasy.
As a result, politicians now have to take responsibility for the policies they pursue as economists no longer provide politicians with a fig leaf of intellectual cover.
More than three years after the end of the global recession, sluggish activity across rich and poor economies is confounding policymakers who expected more by now and raising concerns that options for kick-starting growth are increasingly limited.
They face a sobering checklist:
The U.S. economy remains shackled by a mountain of household debt and continues to whipsaw between periods of modest growth and next to none at all.
The euro zone is mired in recession, lurching from crisis to crisis and now dealing with the latest trouble spot in Cyprus.
And even such star performers as China and Brazil have run low on gas. China in 2012 posted its weakest year of growth since 1999. Brazil's economy slowed to a near standstill; at the same time, it faces a growing threat from inflation.
Against this backdrop, the exasperation of finance ministers and central bankers attending last week's Group of 20 and International Monetary Fund meetings was palpable.
The official communiques and sideline discussions reflected their frustration over the failure so far to deliver an effective mix of policies to finally get an upper hand on a long-lasting crisis that shows little sign of ending.
"We cannot unmistakably declare that the worst is behind us," Brazilian Finance Minister Guido Mantega said on Friday. "There is a risk of a prolonged crisis, despite all our efforts in the G20 and other international forums."
Central banks across the developed world have held interest rates at rock-bottom levels since 2008 while pumping more than $6 trillion into their banking systems through loans and asset-purchase operations known as quantitative easing, or "QE." The European Central Bank has helped lower borrowing costs for the governments of Spain and Italy. Ireland, Portugal and Greece have been bailed out.
And yet a return to normalcy appears a distant dream....Were the Swedish Model now adopted, we could be back to normal in 12 months.
"You're not going to have a perfectly optimal set of policies for everyone in the world," said Tharman Shanmugaratnam, chairman of the International Monetary and Financial Committee, which advises the IMF on the global monetary and financial system.
Tharman said the trick was to find a mix of policies that would help economies grow without risking future bubbles. "We need a new framework," he said.The new framework is simple: adopt the Swedish Model and bring transparency to all the opaque corners of the financial system.
Good for the global economy, good for society and bad for banker cash bonuses.