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Defining the financial safety net Samuel Brittan International Economy Winter 2008 A return to first principles – Avoiding creeping guarantees Why should there be a safety net for banks and not for the steel industry, textiles or other victims of economic change? The cliché reply is that money, as the lubricant of the economic system, is "different". This might have had plausibility when there was a hard and fast line between banks and other financial institutions. Central bank safety nets could in principle be extended from deposit banks to investment banks. But there would be no shortage of other corporate bodies claiming to provide similar services; and if we are not careful, safety nets would be demanded for most of the economy, which would be either impossible or disastrous if attempted. As I write, the British authorities are trying to define their guarantee to Northern Rock depositors without a limitless spread of guarantees. Ordinary citizens are entitled to a modern equivalent of keeping dollar bills or sterling notes under the mattress which avoids the physical hazards of such procedures. To this end Henry Simons, a Chicago economist writing in the 1930s and 40s, proposed the creation of pure deposit-taking institutions ("hundred per cent money") whose assets would have to be held in currrency or Federal Reserve deposits. ("A Positive Program for Laisssez Faire"). Other financial institutions, whether or not called banks, would carry on paying interest and looking for more profitable investments. Those using them would learn that higher returns came with higher risks. The idea is not as far-out as it seems, as it would be possible to build on the state-sponsored National Savings instititions existing in several countries, for instance by providing for faster withdrawals and allowing cheques to be written against them. The immediate task for governments and central banks is to prevent a contraction of world demand without overdoing it and sowing the seeds of the next inflation. But this is also the time to take a longer term look at the financial system to try to reduce the frequency and severity of monetary crunches.
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