Wednesday, January 23, 2008
The Macropocalypse and the Perversity of Global Monetary Policy
A significant portion of the rotten DNA in the financial system is inside central banks.
There are many reasons, but to get to them, we've gotta connect the dots first.
What's really going on in terms of monetary policy?
The rot in the financial value chain is deepest in the States, where the seeds of the implosion were sown. And that's where the Fed slashed and burned rates like never before.
Across the pond, in Europe and the UK, where the rot isn't nearly as deep, and which received - rather than ignited - the virus, the ECB and BoE and refuse to cut rates.
That's a seriously perverse outcome.
If anything, monetary policy should be working exactly in reverse: tiny or no cuts in the States, to let the market punish transparency into the value chain and defeat the structural incentives for moral hazard; and significant cuts in Europe and the UK, to stabilize liquidity until said transparency does emerge.
This doesn't bode well for the immediate future. Central bankers have been, it seems, divided and conquered by the virus they should be working together to eradicate.
Im quite sure you would be interested in what this guy has got to say. He makes some similar points - about the irresponsibility of banks - but draws some somewhat different conclusions:
These are two separate points.
The first one is on the 'irresponsible' behaviour of the central banks, in particular the Fed. I guess there is both a fundamental aspect to this, as well as a comment on the most recent behaviour. I agree with this. The Fed in particular is flawed at its root. Its main mission is not to create a stable currency, but to minimise unemployment. This leads to one problem after the other. The Bank of England, as an example, does not have the remit to reduce unemployment, but only to create a stable currency and financial system. It works much better.
The other point is one on the instability of banks. This is also correct. In my view, bansk have an insufficient requirement to keep liquid reserves to cover their trades. So, in good times, they pay all the profit out in bonuses and in bad times, they simply have insufficient funds to cover their losses. I agree that this should get tackled by the regulators.