Answer One of the Following Two Questions:
1. Kindleberger adopts a "Minsky model: of financial booms and crises, named after the economist Hyman Minsky. Describe the dynamics posited by this model, including not only the basic sequence of events (initial displacement, speculation, euphoria and overtrading, surprise event, distress, revulsion, and liquidation), but also the following detailed aspects:
(a) the role of hedge, speculative, and Ponzi finance;
(b) the role of memories of prior crises, and the ebbing out of these memories;
(c) the effects of repeated lender-of-last-resort actions on the development of financial crises in the future;
(d) how credit expansion not controlled by the authorities imparts momentum to "speculative manias";
(e) how different financial crises differ from each other; (f) the limitations of traditional supply and demand analysis for analyzing financial cycles, given the role of history, psychology, and institutions.
2. Explain what the "lender of last resort" (LLR) is, and its specific tasks from the standpoint of Kindleberger's model of financial crises. Discuss the issues raised by the LLR. Among the issues, you should deal with at least the following:
(a) the problems involved in implementing a sound LLR policy (e.g., responsibility, allocation, timing, targeting);
(b) alternatives to official LLR actions;
(c) why private LLR operations are probably insufficient;
(d) the long-run effects of repeated bail-outs (moral hazard and too big to fail problems);
(e) the inequalities produced by LLR actions;
(f) the problem of "cronyism," as described by David Stockman;
(g) the role of financial regulations and penalties for excessive risk-taking and fraudulent behavior;
(h) the difficulties involved in extending the LLR to the international level.