Policy in the wake of the banking crisis: taking pluralism seriously

Abstract

This paper explores a pluralist approach to policy with respect to the financial system in the wake of the crisis. We consider first what is involved in a pluralist approach to policy more generally, and how this may be justified. This includes a pluralist stance with respect to different approaches to economic theory, pluralism in the sense of interdisciplinary enquiry, pluralism in terms of the range of methods employed, and pluralism with respect to recognition of the plurality of culture and values in society. Implications are drawn for how the banking crisis is framed, how it is explained by theory and thus how policy is designed. In addressing these issues, current mainstream theory focuses on a narrow definition of rational behaviour which, within competitive markets, generates a socially-optimal outcome. This approach is governed by a mathematical formalist methodology, and encourages policy to incentivise this kind of rational behaviour, with respect, for example, to inflation targeting and addressing moral hazard. Pluralist theory would instead recognise the socio-psychological and institutional/evolutionary foundations of money and banking, such that policy needs to focus on rebuilding confidence and addressing moral (including distributional) issues. The relevant analysis would require a range of methods and would address pluralities within society.

Keywords:

• pluralism
• monetary policy
• bank regulation

JEL Classifications:

• B41
• B50
• E58
• G28

Acknowledgements

This paper has benefited from discussions in the ‘Pluralism in Crisis’ Workshops, Institute for Advanced Studies, Strathclyde University, summer 2010, following presentation to the Economic Policies for the New Economic Thinking Conference, St Catherine’s College Cambridge, 14 April 2011, and from comments and suggestions from two anonymous referees.

Notes

1. We do not focus on pluralism at the level of theory on the grounds that all approaches generate a plurality of theories. While several commentators have identified pluralism in mainstream economics, what is generally meant is pluralism only at the theoretical level.

2. As we explore further below, the plurality of understandings is part of this plurality.

3. Framing is a form of conceptualising complex reality and can take a variety of forms. In particular, the economic theorist will employ a much higher level of abstraction than the non-theorist.

4. The term ‘narrow banking’ is confusingly applied to both types of system.

5. Interest rate policy depends on the markets’ expectations of what the central bank will do; these expectations are inputs to the forecasts on which monetary policy is based.