Over at the Financial Times, Tim Leunig – occasional contributor to LDV, and reader in economics at the London School of Economics – considers the unusual financial origins of the current recession. Here’s an excerpt:

The global economy would benefit from a pre-announced, temporary, globally co-ordinated bout of moderate inflation. Since it takes about two years for central-bank policy fully to influence inflation, a sensible policy would be to target 4 per cent inflation for the five years from 2011, followed by 2 per cent thereafter. … An increase in inflation by an extra 2 percentage points for a period of five years would have many benefits – for governments, companies, households and the banking system. …

An extra 2 points of inflation for five years is not a “get out of jail free card”. Bank shareholders, rightly, will still lose greatly from their managers’ decisions. Future taxpayers will, inevitably, still bear most of the cost of counter-cyclical government spending. … The policy aims to improve the health of the banking system so growth can resume, while dividing the cost of paying for the mistakes of the past more equitably.

We can go too far. Inflation much above 4 per cent risks starting an inflationary spiral. Higher inflation for too long risks creating permanently higher expectations and stoking future booms. In addition, savers should not pay a disproportionate share of the cost of this recession. Advocating a policy that cannot be guaranteed to work, and that is neither costless nor riskless, is not usually sensible. It is a measure of the unusualness of this recession that such an idea is worth considering.

You can read the article in full at the FT’s website by clicking here.