“What have we learned about money and banking during and since the Great Recession?”

As announced last month on this blog, you can find now the video of the IIMR 2016 Public Lecture given by Charles Goodhart (Financial Markets Group, LSE) available on the Institute of International Monetary Research website: http://www.mv-pt.org/2016-lecture-and-conference

Professor Goodhart, indeed a distinguished academic figure in monetary economics in the UK and a former member of the Bank of England’s Monetary Policy Committee, criticised many features of monetary policy-making both before and after the sharp global downturn of 2008 and early 2009. He also underlined some of the most important flaws in current macroeconomic models:

(1) The use of macroeconomic models with no money, nor a banking sector.
(2) No analysis of the monetary transmission mechanisms via the banking or the wider financial sectors.
(3) The assumption that there is a direct correlation between changes in the monetary base and changes in the amount of money.

In my view those flaws are yet to be properly addressed and if we could just agree on those very simple points we would make a major progress in current monetary economics! And we will very much reduce monetary instability and thus minimise the risk another financial collapse.

Just a final note on the Institute of International Monetary Research. Its main purpose is to demonstrate and to bring public attention to the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other. The Institute has been established in association with the university of Buckingham and is heavily involved in the analysis of banking systems, particularly their role in the creation of new money balances. You can subscribe to its newsletter and publications here: http://www.mv-pt.org/contactus

Juan Castañeda

PS. The text with the lecture will be available soon at the IIMR website.

 

Advertisement

Read Full Post »

Monetary economics after the crisis: painful (ongoing) lessons

The recent financial crisis has challenged quite many of the benchmarks and established monetary economic theory used in the 1990s and 2000s to analyse and prescribe monetary policy decisions. To be frank, we all have learned something in the recent crisis. Let me just list some of the lessons of the crisis I believe all and sundry very much agree on:

• Changes in the monetary base are not good indicators of overall inflation. The three, four or even fivefold expansion of the central banks’ balance sheets has not been accompanied by inflation. It is broad money what explains inflation over the medium and long term.
• In times of crisis, and even more if severe banking/financial crises occurred, central banks are not (cannot be) independent. In their current form central banks are indeed the bankers of governments and this becomes very evident when public revenues collapse and public spending soars, resulting in a much more expensive access to credit (if at all) and a greater and greater appetite to borrow money from the central bank. Perhaps the best we can do is to run healthy public finances in times of expansion so that the threat of ‘fiscal dominance’ is minimised and contained as much as possible.
• CPI ‘inflation targeting’, at least as pursued in the years prior to 2007/08, is not enough to preserve monetary and financial stability over the medium and long term. Particularly in the four years running up to the crisis CPI inflation remained fairly stable (with some spikes though to oil price shocks mostly) and central banks achieved their inflation targets, consisting in a rate of Consumer Price Index inflation around 2% over the long term. However many other economy prices, in particular both financial and real assets’ of various types, did increase quite significantly, and now we know that in an unsustainable way.
• At least in the current institutional setting, the lender of last resort (LOLR) function of central banks is an essential tool to preserve the functioning of monetary markets and thus of financial markets. As I will detail in a later post this does not mean bailing out too risky and insolvent banks (and even less bailing out their managers and shareholders), but preserving the sound operation of the financial and payments systems as a whole. The conditions to do this are very well-known to monetary historians and I am afraid they are many times forgotten.
• Monetary aggregates (money) played virtually no role in the framing of monetary policy decisions before the crisis. However, it has been more than eight years now with historically low (policy) nominal interest rates, so central banks have had to resort to a different source of policy measures; that is, the expansion in the amount of money by the so-called Quantitative Easing (QE) operations. And what are they but purchases of bonds and even equity that ultimately aimed to increase the amount of money in the economy?
• Central banks are not running out of weaponry. In our modern monetary systems, where central banks create the ultimate source of liquidity in the economy, there is virtually no limit for central banks to create more money. Central banks can (as they have done in these years) extend the maturity and the amount of the lending provided to the banking sector, increase their purchases of both private and public assets from financial and non-financial institutions, they can also purchase equity in the market, … .
• Tightening bank regulation in the midst of one of the worst financial crisis in recent history can only aggravate the impact and length of the crisis. The raising of the capital ratios and the establishment of new liquidity ratios by the so-called ‘Basel III Accord’, initially  announced in the Autumn of 2008, forced banks to even contract more their balance sheets (to cut down their liabilities, deposits mainly). This resulted in sharp a fall in money growth and the worsening of the crisis, which had to be (partially) offset by central banks extraordinary policy measures (such as QE) to prevent money supply from falling even further.

There are many other much more disputable issues related to monetary economics and monetary policy indeed. But if we only agreed on the above we would be putting a remedy to some of the biggest gaps if not ‘holes’ in this field and thus creating the conditions to establish a much sounder and sustainable monetary policy framework.

I will devote a single entry to each of the them in the following weeks.

Juan C.

 

Read Full Post »