Is a Plumber or a New Financial Architect Needed to End Global International Liquidity Problems?

Abstract

The paper starts with a critical review of two alternative theories of capital markets: neoclassical efficient-market theories and Keynesian liquidity preference theories, which differ radically in their views concerning the functions and operation of capital markets. Contrasting the experience of the global economy in the pre- and post-Bretton Woods eras, the author finds that the facts do not support the efficient-markets hypothesis. Indeed, instead of fulfilling the utopian promises of greater stability, more rapid growth and full employment predicted by efficient-markets theorists, liberalization of capital flows in the post-Bretton Woods era has been associated with exchange rate instability, financial crises, slower global economic growth and greater unemployment. The theoretical implication of the contrast between theoretical expectations and performance is that a Keynesian reformulation of the micro-foundations of economic analysis is required. The policy implications are that a return to a fixed-exchange rate regime, coupled with restraints on the international movement of capital and supported by a clearing-union, are essential. The paper concludes with a proposal for a comprehensive, interconnected package of reforms.