1. Introduction

Despite the creation of a myriad of US Federal Reserve (hereafter referred to as the Fed) special discount window facilities, unlimited swap lending by the Fed to central banks throughout the globe and the use of Troubled Asset Relief Program (TARP) funds to bolster bank capital there appears to be little improvement in conditions in financial markets and it is widely lamented that the banking system is not providing lending to support the private sector. Comparison of the response to the 1930s Great Depression and the similar crisis in Japan in the 1990s suggests at least three factors that are absent in current policy: (i) direct measures to support bank incomes through interest rate policy, (ii) a clear understanding of the failures of the ‘modernised’ financial system, and thus (iii) a clear design for the shape and structure of the financial system that is to replace it.

2. Diagnosis Is More Important than the Cure

The prevailing diagnosis of the difficulties involved in reviving the financial system is based on the idea of a ‘liquidity trap’. This explanation is similar to that proposed for the 1990 Japanese crisis that followed the collapse of a bubble in equity and real estate markets eerily similar to that recently experienced in the USA.