In essence, resolving the crisis in confidence needs the current ad hoc approach to be replaced with the structure of a more formal mechanism that will generate the confidence in the world financial system needed to restore stability in world markets.
Let me offer some multiple choice questions.
1. What should be the stance of U.S. monetary policy?
a) The Fed is out of ammunition (.0001)
b) The Fed needs to worry about hyperinflation, so it should not attempt any further expansion. (.0499)
c) The Fed should be trying to expand the money supply, and if anything, a little more inflation would be a blessing (.95)
The numbers in parentheses are my estimate of the probability that the answer is correct.
Scott Sumner and Ken Rogoff, two economists with different perspectives but who have been right more often than wrong about the current situation, both favor (c). So do I.
Answer (b) sounds like something out of the Tea-Party fringe. But it is indistinguishable from current Fed policy, which is to note that the economy is weaker than anybody would like, and therefore no policy change is required (If this were chess, I would be putting ??? next to the Fed's choices these days.)
Answer (a) strikes me as nuttier than anything that has come out the Tea Party fringe. The Fed cannot be out of ammunition as long as it can buy stuff by printing money. Conceivably that could happen if the cost of printing money were higher than the value of the stuff that you can buy with it. But we are nowhere near that point. And it's hard to get to that point in an era where printing money can be accomplished by moving bits on a computer network.
2. What should be the stance of fiscal policy in the U.S. and other countries that still enjoy the confidence of the world's investors?
a) Tighten up fiscal policy to keep investor confidence. You are going to need it. (.60)
b) Loosen up fiscal policy to stimulate growth. (.10)
c) Stay the course. (.30)
Everyone who has an opinion on this is well dug in. Nobody is changing any minds. My weights show that I am worried about the long-term fiscal outlook. I am skeptical of the Keynesian idea that more deficit spending would be stimulative, but I am not so sure of myself as to consign the idea to the same trash heap where I would throw "The Fed is out of ammunition."
3. Should some European sovereign debt be rescheduled?
a) Heck no. They hired the money, didn't they? (.05)
b) Yes. Soon, while somebody is still solvent enough to issue something comparable to Brady Bonds. What you want is to replace Greek bonds with a face value of $100 with bonds issued by a reliable entity with a face value of, say, $60. (.60)
c) Maybe some day, but not now, fer Chrissakes. The European banks need to strengthen their balance sheets first, or they'll be wiped out! (.35)
The eurocrats are attempting (c). I believe that this will fail, and the transfers from taxpayers to bank creditors are not a good thing. Unfortunately, most respectable people think that Bernanke and Paulson and TARP and such SAVED THE WORLD, and so that is now the model going forward for handling any situation involving shaky large banks.