Financial repression

The term "financial repression" (FR) was introduced by McKinnon (1973) and Shaw (1973) in order to analyse State intervention in financial markets. For these authors, banking interest rate regulations (such as corridors limited by ceilings and floors for both loans and deposits), lending rates of development banks or public commercial banks below the "market" rate, reserve requirement ratios or capital controls are some examples of how governments and central banks "repress" free market forces and block the efficient adjustments of the loanable funds market. Of course, the monetization of fiscal deficits is also a type of FR, but because it is related to government expenditures, it has other implications. Let us therefore focus strictly on monetary and financial policies.

Euro-area crisis

The euro-area crisis burst at the end of 2009, when the newly elected Greek government discovered and announced that the Greek public deficit and debt were much higher, with respect to GDP, than the previous government had claimed. During 2010 a number of euro-area countries in the periphery of that area (Ireland, Portugal and Spain) came under much pressure, because financial markets participants feared that these countries' governments in one way or another were going to default and exit euroland. These pres- sures then extended to Italy as well, in light of its high public debt-to-GDP ratio and a rate of GDP growth close to zero. All these countries have thus been subsumed under the acronym "PIIGS" (formed by their initials), to convey the idea that their financial problems originate in their behaviour, characterized by a profligate fiscal policy and expenditure levels beyond available income.

Federal Reserve System

The creation of the US Federal Reserve System was enacted by the Federal Reserve Act on 23 December 1913, as a response to the severe crisis of 1907, "to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes" (Board of Governors of the Federal Reserve System, 2014, Official title). It was the third attempt to create a federal central banking system, after the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-36) failed.

The US Federal Reserve's duties fall into four general areas: conducting the nation's monetary policy, supervising and regulating banking institutions, maintaining the sta- bility of the financial system and containing systemic risk that may arise in financial markets, and providing financial services to depository institutions, the US government, and foreign official institutions (Board of Governors of the Federal Reserve System, 2005, p. 1).

BIS macro-prudential approach

With the global financial crisis that burst in 2008, the Bank for International Settlements (BIS) is receiving more and more attention for its analysis of financial stability issues. Typical for the BIS is a broad approach to financial stability, "marrying" its micro- and macro-prudential dimensions.

The BIS was set up in 1930 as a forum for central bank cooperation. It provided central bankers with three main services (Toniolo, 2005): research on issues relevant to interna- tional payments and prudential supervision, a venue for regular and discreet meetings, and a financial arm (particularly important in the gold market).

The BIS macro-prudential approach to financial stability had its origin in the late 1970s, when central bankers worried about the strong growth of external debt in develop- ing countries. In this context, the BIS, and especially Alexandre Lamfalussy, its economic advisor, emphasized that a borrowers' market had been developing, mainly because of loose US monetary policies. So, a distinguishing characteristic of the BIS approach is to place debt problems in a broader macroeconomic framework, paying particular attention to the interaction of global imbalances and debt dynamics. The BIS macro-prudential approach referred further to prudential policies that promote the safety and soundness of the broad financial system - and not of individual financial institutions alone.

Bank capital and the new credit multiplier

The ongoing debate on the money supply process (the relationship between bank loans and bank deposits) has recently been enriched by introducing the importance of equity capital (see Lavoie, 2003; Karagiannis et al., 2011, 2012). The importance of bank equity for book (loans) expansion and consequently for financial stability was first identified by the Basel Committee in 1988, then by Basel II agreements (2006) and more recently by the Basel III (2011) capital requirements framework.

The reason for studying the linkages between bank equity and bank lending lies mainly in its possible importance as an alternative monetary policy vehicle. This issue emerged as a by-product of the liberalization process of the banking industry around the world, which induced a lending boom-bust cycle and had to be restricted for financial stability reasons (Goodhart et al., 2004), as well as adding to banks' insolvency risks. Consequently, the Basel Committee issued a number of directives for G10 banks (Basel Committee on Banking Supervision, 1998) that had two supplementary aims: first, to specify the different categories of collateral attached to different bank loans, actually calculating the "net" exposure; and, second, to attribute the appropriate weight to these (collaterally adjusted) exposures.

These directives aimed at reinforcing the Capital Adequacy Ratios (CARs) imposed on the banking sector. However, some years later, the Basel Committee was compelled to issue revised directives (see Basel Committee on Banking Supervision, 2006) in order to describe bank exposures in more detail; these directives were further revised more recently (see Basel Committee on Banking Supervision, 2011).

Bank Act of 1844

The Bank Act of 1844 followed the 1819 return to the gold standard: that is, convertibil- ity of banknotes into gold, which had been suspended since 1797; the 1819 Act stipulated a conversion rate of £3/17s/10½d (3 pounds, 17 shillings and 10½ pence) per ounce of gold.

Fiat money

Keynes (1913, p. 26) famously remarked that the Indian rupee was "virtually a [bank]note printed on silver", by which he meant to suggest two things: that the intrinsic value of the silver did not determine the monetary qualities of the rupee - or even its purchasing power - and that, being a banknote, it was subject to the decrees of the Indian govern- ment. The rupee was indeed a means of payment, not because it was silver, but because government fiat declared it so. If this is the case for a silver coin, then most or all money may be, at least in part, fiat money, because of government decree.

A long tradition has distinguished money of intrinsic value (that is, money based on precious metals) from paper money and bank money. The former monies are "real", and the quantity and value depend on the working of markets; the latter are "fiat money", based on State declarations, and therefore subject to the whims and interests of inher- ently unreliable politicians. But perhaps these forms of money are not so distinct; perhaps fiat money also reflects the markets, and real money rests in part on the rules and policies of the State (Bell and Nell, 2003).