what on earth is altering the entire pathway of money spending in an economy, in order to address potential credit issues?

It tells you a little about the econblogosphere I swim around that I still haven’t read a decent defence of the BIS and their “tighten early tighten often” approach to dealing with perceived credit issues.  The latest excellent assaults on their reasoning are from Simon Wren Lewis and Tony Yates.  SWR points out that that BIS is heading towards a world of ever lower rates:

If you raise rates to prevent financial instability when inflation is below target, inflation will remain below target or may fall even further. You cannot ignore that. So if interest rates are raised today to head off a financial crisis, they will have to be lower in the future to deal with the lower inflation or even deflation you have caused.


(which Friedman predicted in 1968: if you want low rates, deflate).

Tony makes a similar point when he says

“One way of ensuring that interest rates are high forever would be to announce a permanent increase in the inflation target of 5%, or 10% ..Over what horizon, if not the long-run are tightenings effective at curtailing ‘risk-taking’?  Interest rates have been at their floor for 20 years in Japan.  Do we think that the Japanese economy is suffering from irrationally-exuberant risk-taking?”

His post links to interesting work showing how the BIS thinks.  It is a good read.  Low rates cause a search for yield, particularly if institutions have high fixed liabilities (i.e pension funds obliged to provide a return).  They also push valuations to high levels.

I think there is no doubt some empirical truth in this but the causality is all messed up.  A world of low rates often means tight money. Low incomes, difficulty servicing debts.  It may well induce in financial and asset markets some high valuations (which is why “stock market soaring means money easier” may be problematic for market monetarists).  This is all a dangerous cocktail.  But the answer is easier money – higher incomes, higher NGDP growth, and higher rates.

Is it possible that one of the reasons for a lack of financial crisis in the West for many decades was nothing to do with Glass-Steagall, wise regulation or the Governor’s Eyebrows, but high nominal growth?  When that is happening, fixed nominal obligations – debts – dissolve far more quickly.

Policymakers are right to look to macro prudential tools if they are worried about credit issues.  To their victims, crude limits on mortgage lending above a certain riskiness and rules about their market exposure to this or that must look very statist and crude; using sledgehammers for brain surgery. But I doubt they are much more crude than the rules banks etc set themselves when setting strategy.   What is crude is to attempt to control the behaviour of a few financial markets by messing with the monetary conditions of an entire economy.  This is like flooding the valley to deal with a house fire.




One thought on “If macroprudential tools are like sledgehammers …

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