The Bank FOR*** International Settlements has been making front page FT news (£) recently with its warning that we need tighter money to guard against bubbles. The piece kindly refers to other such warnings made in 2003. As Ryan Avent highlights, however, they seem to have been foreseeing dozens of the next asset bubble.
Cards on table: I think Ryan is basically the best economics writer alive, and reliably zeroes in on issues that really really matter. His piece utterly flays the BIS:
In 2011, when unemployment rates in both Europe and America were above 9%, the BIS argued that global growth needed to slowin order to reduce inflationary pressure. In 2012 it warned that central banks shouldn’t do any more to boost growth lest they create financial instability and discourage structural reform, even as the crisis in the euro area threatened to tip the rich world back into serious recession. Though the BIS’s diagnoses of the global economy’s ills have evolved over time its policy recommendations have not.
He then gets to the nub of the matter, which is analytical.
This misreading begins with its assessment of the stance of monetary policy; in the BIS’s view low interest rates are indicative of loose monetary policy. My colleague seconds this view, writing that central banks are determined to “keep monetary policy as loose as possible for as long as possible”.
My emphasis: within the very same magazine they don’t agree about what Loose Money means. Ryan’s colleague P.W. gives away how wrong he is in the very first line:
CENTRAL banks in the developed world continue to keep monetary policy as loose as possible for as long as possible in order to facilitate a stronger recovery from the painfully weak upturn after the financial crisis and the “great recession
What does PW mean by “loose”? Presumably he thinks “they have cut interest rates and done loads of QE. The financial sector is going mad with it all”. Or something like that. But Milton Friedman explained this in an address to the AEA (i.e. a really prominent event) in 1968:
As an empirical matter, low interest rates are a sign that monetary policy has been tight-in the sense that the quantity of money has grown slowly; high interest rates are a sign that monetary policy has been easy-in the sense that the quantity of money has grown rapidly … Paradoxically, the monetary authority could assure low nominal rates of interest-but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy … These considerations not only explain why monetary policy cannot peg interest rates; they also explain why interest rates are such a mis- leading indicator of whether monetary policy is “tight” or “easy.”
And Mishkin in his tome on Money has lessons on p610 (after exhaustive teaching and historical evidence) including: don’t associate easing of policy with a fall in rates: “there is a danger that central banks will focus too much on short term nominal interest rates as an indicator of the stance of monetary policy”. Including, it seems, the central banks’ central bank, and the world’s leading economics magazine.
And most commentators. Most of the time, when arguing with people online about what monetary policy can or cannot do (see this) I realise that many others have a mental model in which monetary policy is lending. So the last 5 years have been about the central banks lending money to the banks who then refuse to lend the money to the real economy, the SMEs*, because demand is low.
And we all know that lending too much has to end some time and is the road to ruin. Hence BIS’s warnings not to put off the inevitable. In their Austrian model, QE etc are like a household “maxing out the credit card” in order to forestall the inevitable, and keep living higher-on-the-hog than they can justify. (The fiscalists, on the other hand, think borrowing is fine, just through the state who can make the money work).
We need a better, clearer definition of easy money, that catches up with the level of insight common in the 1960s.** On a qualitative basis, it can be seen in all sorts of ways. Bills are paid quickly. Assets are easy to sell. Suppliers have easier terms. Money is easy to get! Can money be ‘easy’ when the FT carries stories saying “late payment is the biggest challenge”? No. Money is easy when money is easy to get. This can be associated with high rates. In the 1970s, when inflation was high, there was a very strong incentive to pay bills very quickly. Money was easy and NGDP booming. In the 1920s UK, when deflation was rife, rates were low. You held onto money. Money was tight.
I will be repetitive. Central banks are not really about lending money. Credit conditions can go nuts without there being a great quantity of reserves swilling around – look at 2004-7!. Money is not extremely loose just because rates are low. Monetary policy does not rely on “investors getting the money” or any other “lending” model. Looser money increases NGDP, tighter money decreases it.
And the BIS seems to be reliably wrong.
*it is a law of the land to add “who are the backbone/lifeblood of the economy”
** or the 1930s. They understood it better in this video