achilles, I do see your argument, but I am not sure what you're advocating...
If the central bank makes their backstop/insurance explicit, as you seem to suggest, the result would be excessive risk, moral hazard and financial institutions engaging in proper brinkmanship. That, to me, is unlikely to be the solution.
On the other hand, if they allow financial institutions to fail, they need to worry about stopping potential runs. In fact, it doesn't really matter how these runs arise. They might happen as a result of a failure of a single systemically important institution or a bunch of simultaneous smaller failures. As long as you allow the possibility of investors behaving irrationally and herding, runs can happen.
So the question is, really, how to reduce the probability of a run. For individual depositors, the DIF seems to have worked quite well. Unfortunately the economy isn't funded by deposits any more. Reducing the maximum size of financial institutions would also help, hence the whole discussion of 'too big to fail'. The real issue, however, is the asset bubbles and the imbalances, which cause herding. How you might be able to address those is the bazillion $ question.
If the central bank makes their backstop/insurance explicit, as you seem to suggest, the result would be excessive risk, moral hazard and financial institutions engaging in proper brinkmanship. That, to me, is unlikely to be the solution.
On the other hand, if they allow financial institutions to fail, they need to worry about stopping potential runs. In fact, it doesn't really matter how these runs arise. They might happen as a result of a failure of a single systemically important institution or a bunch of simultaneous smaller failures. As long as you allow the possibility of investors behaving irrationally and herding, runs can happen.
So the question is, really, how to reduce the probability of a run. For individual depositors, the DIF seems to have worked quite well. Unfortunately the economy isn't funded by deposits any more. Reducing the maximum size of financial institutions would also help, hence the whole discussion of 'too big to fail'. The real issue, however, is the asset bubbles and the imbalances, which cause herding. How you might be able to address those is the bazillion $ question.
