News about financial stability, central banking and theory of money
This post gives a good review of the issues and consequences of pesistent Negative Interest Rate Policy (NIRP)
The NIRP acronym is misleading, however, because unlike ZIRP, NIRP isn’t actually an official “policy” per se, but rather a symptom of a broken financial system increasingly starved for good ‘collateral’.
This phenomena, thought by many to be of short duration, is now having its impact on investors, especially insurance companies and pension funds.
The impact is felt only gradually, but will get worse if NIRP continues. Together with the crisis in the real economy, this dosn’t look good.
Intersting summer interview with top brass Andy Haldane in Bank of England. He reflect on the state of economics and the need for financial reform.
He makes the case for fundamental uncertainty (as adwocated by Keynes and Hayek) and notes that this insight somehow got lost from economics and finance for the better part of 20 or 30 years! Quote:
I think one of the great errors we as economists made in pursuing that was that we started believing the assumptions of economics, and saying things that made no intellectual sense. The hope was that, by basing models on mathematics and particular assumptions about ‘optimising’ behaviour, they would become immune to changes in policy. But we forgot the key part, which is that the models are only true if the assumptions that underpin those models are also true. And we started to believe that what were assumptions were actually a description of reality, and therefore that the models were a description of reality, and therefore were dependable for policy analysis. With hindsight, that was a pretty significant error.
As for financial regulation, he thinks we may have to go even further in rethinking finance and banking before the crisis is over.
Quite an interesting read from a key central banker today.
According to FT today, the Bank of England will be subject to three independent reviews, of its LLR role during the crisis, of its current liquidity policies and of the MPC inflation forcasets.
This is not surprising, as pressure has been building for some time to subject the BoE’s crisis performance to scrutiny. Also, there has been reports of too much group-think within the bank, and too much hierarchy within the Court of King Mervyn.
The reviews are welcome, but one wonder why their Financial Stability Reviews are not subject to review as well. After all, it was that part of the bank that was supposed to take appropriate measures to guard financial stability.
This recent speech from IMF Managing Director Lagarde confirms the austerity for growth paradigm that has taken hold recently. She notes that to get growth
The most important element is to lay out a credible medium-term plan to lower debt. Without such a plan, countries will be forced to make an even bigger adjustment sooner.
The current reduction of budget deficits with about 1 % of GDP on average is at a “prudent pace”, according to Lagarde.
As for the southern European countries that has lost competitiveness, the choice is between increased productivity or lower wages. But since labor market reform takes time, “wage will have to adjust” (read: fall).
It is remarkable how the IMF has changed since Mr. Strauss Kahn provide strong leadership out of the 2008 financial crisis. I just quote from one of his many press releases, this one from November 15, 2008 commenting on the G-20 Action Plan:
Mr. Strauss-Kahn noted the G-20 leaders’ commitment to act together to meet global macroeconomic challenges, using both monetary and fiscal policy. Lower inflation risks provide room to ease monetary policy, he said, adding that this will be important, but will not be enough.
“I welcome the emphasis on fiscal stimulus, which I believe is now essential to restore global growth,” Mr. Strauss-Kahn said. “Each country’s fiscal stimulus can be twice as effective in raising domestic output growth if its major trading partners also have a stimulus package.”
He noted that the Summit Declaration recognizes that some countries have more room for maneuver than others. “We believe that those countries-advanced and emerging economies-with the strongest fiscal policy frameworks, the best ability to finance fiscal expansion, and the most clearly sustainable debt should take the lead,” he said.
The FT’s editorial today with a balanced call for austerity in Europa was surprising and disappointing, given all the writings of Martin Wolf and others in the paper before. Today Brad de Long take charge at the ed and discuss why it is that people who should know better fall in the “austerity trap”. He points out that even Milton Friedman would have to to stabilize nominal GDP and buy stuff for until inflation and growth are reestablished on a sustainable path.Well written.
Also included are the response from Paul Krugman which is even better, and probably well to the mark (still scary):
My best theory here is that it’s political and sociological: conservative-leaning economists who should know better are driven by peer pressure to suppress their better instincts.
Think about Greg Mankiw and inflation. Early on in the Lesser Depression Greg came out for inflation — fairly high inflation! — as the solution, to give us negative real interest rates. But he encountered a firestorm of criticism from his political allies — and went silent.
The point is that even among academics with tenure and established reputations, there is apparently enough leverage in the hands of the enforcers of right-wing orthodoxy that they end up bowing to the reign of error.
As for Rachman: I think this is a subtler form of peer pressure. And for what it’s worth, Ryan Avent has already written the devastating reply to Rachman I haven’t had time for because I’m on Reddit!
Todays hearing in the Senate Banking committee on the MF Global bankruptcy were supposed to deal with how we can avoid a similar debacle in the future. Much of the action was still on where the money went and how this could happen. Not so much new information during a short two hour session, but obvious that the relevant rules (1.25 &30) could be used in a quite flexible way as a result of previous strong lobbying by Goldman Sachs (for rule making proposal to straighten up this loophole, see here, and for the objections from MF global, see here). Unbelievable that CFTC let them continue with investing client money in European debt and in-house repos! Gensler, chairman of CFTC and former colleague of Corzine at GS obviously has a problem with this case (he has left it to his commissioner Sommers to handle the case on the Hil)
This post from January capture the angry (and probably correct) mood among the MF Global clients, when it comes to lack of fair treatment. And nobody should believe that the money just “vaporized”. They were stolen twice!
This paper by Brad DeLong – This time, it is not different – argues that Bagehot’s book on Lombard Street is still relevant for understanding the current crisis, and that mainstream economics for years have failed to pick up the interesting research topics that Bagehot discussed back in the 1870.
Whereas I agree with deLong’s view that Bagehot is still relevant (for my take on the story, see this paper on “Terms and conditions of central bank liquidity support”, http://works.bepress.com/thorvaldgrung_moe/ ), I think DeLong dismisses a long and relevant theory tradition rather summarily when he in the beginning of his paper dismisses Minsky’s book and articles as irrelevant. This is unfortunate, as Minsky and Keynes (and all the others on which they built, including Henry Simons, Minsky’s teacher at Chicago University) had a pretty good grip on the theory of financial crises.
For more on this and the need for a new understanding of banking in macroeconomics, see my working paper on “Shadow banking and the limits to central bank liquidity support“, where I discuss many of the same issues that DeLong raises.
Global liquidity provision is highly pro-cyclical. The recent financial crisis has resulted in a
flight to safety. Severe strains in key funding markets have led central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask how elastic the supply of central bank currency should
I address this question in a new Working Paper from Levy Institute: Shadow banking and the limits of central bank liquidity support. The paper review the recent expansion in central bank liquidity support, including their collateral polices, and then suggests that central banks should not unconditionally supply liquidity to a banking system that is growing uncontrolled. Stricter controls are required unless central banks again will have to underwrite dysfunctional markets.
The paper also provides input to the ongoing Krugman – Keen discussion on banking. See especially section 6 on excessive global credit and section 7 on A new view of banking.
Great conference at the Board of Governors last week: Central banking, before, during and after the crisis. “Everybody” was there, but unfortunately only by invitation. The program is out on the web, including Bernanke’s intro remarks, where he noted that:
“the events of the past few years pose serious challenges to the conventional, pre-crisis views and approaches of central banks and other financial supervisors”, and “we have much to learn about the workings and vulnerabilities of our modern, globalized financial system and its interactions with the broader economy”
Interesting papers by Gertler, Shin, Goodhart, Orphanides, Duffie and Aycharia (plus all the others “who is who” of academic central banking research). Should be worth the read.
No papers yet from the concluding discussion among Mervyn King, Caruana and Shirakawa, but obviously a lot to be discussed.
As Gillian Tett of the FT observed recently : “the crisis has tossed central banking into an intellectual limbo”.
Hopefully they found some of the answers in Washington DC last week!
Financial Stability News 