Credit Creation

The financial instability hypothesis (FIH) was developed by Hyman Minsky in the 80s and early 90s but only gained strong popularity in light of the global financial crisis (GFC) of 2008. The hypothesis is essentially a claim that the financial systems of developed nations are fragile and unstable, where prolonged periods of economic booms will result in a collapse of the financial sector. Among proposals by others, Minsky continuously advocated for policies to deal with these conditions, however, such policies were largely ignored until recently. This essay will analyse and apply the FIH, examine policy recommendations to reduce financial fragility within the financial sector and also outline key shortcomings of Minsky’s hypothesis.

All of economics - hypothetico-axiomatic deductive equilibrium economics that is - agrees that lower interest rates stimulate growth and higher rates slow growth. This claim has been made so frequently in the past half century and beyond that one likes to assume that it refers to a well-established empirical fact. However, there is no empirical evidence. This paper presents the first thorough empirical study on this question. The claim is found to be untrue. There are major consequences for economics, research methodology and ecological economics.

In 1947, in his book An Outline of Money , Geoffrey Crowther compared the pre and post second world war assets and liabilities of the Bank of England and the Federal Reserve, to show how these two apex banks were used by their respective governments to suck all the resources in the form of gold, and for money creation in order to finance the war (Crowther, 1947). I replicated the analysis for the Reserve Bank of India by taking the figures of its prewar assets and liabilities as of Friday, December 9, 1938, and the postwar statistics as of Friday, December 21, 1945, gleaned from The Indian Express of 18 Dec 1938, and of 30 Dec 1945, respectively. As expected, the RBI too was used for monetary inflation but to a much more severe degree. The notes in circulation had swelled during the war only 2.56 times of their initial level in England, while in India they expanded 6.57 times of the initial level, thus making the inflationary pressure 2.57 times more severe in India in comparison to England! Not only this, the RBI was used to suck great amount of bullion and gold coins from India to England, and that too pretty cunningly. The money sucked through the infamous “sterling balances” was over and above this.

Islam banishes interest. This raises two questions contextual to Central Banking. First, can Islamic banks create credit like the conventional? We shall argue that Islamic banks cannot avoid credit creation; an imperative for staying in the market where they operate in competition with their conventional rivals. Evidently, the interest rate policy would not be applicable to them as a control measure. This leads us to the second question: What could possibly replace the interest rate for Islamic banks? In reply, the paper suggests what it calls a leverage control rate (LCR) as an addition to Central Banks' credit control arsenal. The proposed rate is derived from the sharing of profit ratio in Islamic banking. It is contended that the new measure has an edge over the old fashioned interest rate instrument which it can in fact replace with advantage. It can possibly be a common measure in a dual system.