Wednesday, April 29, 2009

A policy faux pas

Isn’t this a little like shooting yourself in the policy foot? According to The Independent, Bank of England Monetary Policy Committee (MPC) member Kate Barker said the following:
[lenders] "are right to be extra careful today in light of future
uncertainties, with unemployment and repossessions continuing to rise."
The central bank uses the credit markets to stimulate the economy; and half of that equation is the supply side, i.e., lending. For the central bank to tell lenders that they are “right” to be cautious is more likely to get banks not to lend rather than to lend.

To be sure, Barker is right, and don't bankers know it! However, to pat banks on the back for being tight with the loanable funds seems like a central banker mistake to me.

Rebecca Wilder


  1. well personally I'm fed-up with double-talk/gobbledygook. We all know she's right, so straight-talking even at this simplistic level must be refreshing. We're not children and we need to know how to deal with reality, not la-la land.

  2. If you believe in social engineering, and that there is a method or plan to the madness, read to the end of the article. We may not be children, but we might become renters. Banks will reduce risk by loaning out to landlords, thereby placing greater assets in the hands of the few. Recovery may not resemble the days when home ownership was perceived as desirable, or even possible, for the many.

  3. I have mixed feelings about this. Standard economic theory says you want to encourage banks to increase lending during a downturn. However, that seems to assume that the market price of the collateral properly reflects (or undervalues) its intrinsic value. During most downturns, this assumption is true. The problem we have today is that real estate has been substantially overvalued, and due to stickiness, prices are only gradually correcting themselves. Britain's housing bubble is even bigger than America's.

    In the short run, all lending is stimulative. But in the long run, any loan that isn't fully repaid has a net negative effect on the economy. (I could be wrong here. Perhaps the money is simply transferred from the lender to the borrower to the person the borrower bought from.)

    To put it another way, stabilization policy says that during a downturn, you want to take $X from a future boom and shift it to the present. However, if lending is done against bad collateral, you are actually taking $X + $Y from a future boom in order to have $X today. If I'm right, then the net loss to the economy ($Y) is permanent.