Two years ago the world was agreed that the aftermath of the banking crisis required the most delicate handling. World leaders were alert to the example of the United States in the 1930s and Japan in the 1990s after its financial crash. In both cases a too-early return to the principles of good housekeeping and premature public belt-tightening caused a terrible wobble in the recovery.
This time it would be different. Governments would spend and borrow to keep the recovery going, recognising their special responsibilities while both consumers and businesses were carrying enormous levels of private debt – and banks were crippled. They would spend to compensate.
Actually the consensus was that Milton Friedman and Anna Schwartz were right. That what turned the 1929 stock market crash and recession into the Depression was the disastrous collapse in the money supply.
This collapse caused partly by the banking system failing, partly by the Fed itself.
So, what have we done this time around? We\’ve slashed interest rates and come up against the lower bound. To beat that we\’ve done quantitative easing. We\’ve also supported the banks, to make sure that their role in credit creation…..or rather their absence leading to no credit creation…..does not shrink the money supply.
And do note that this is entirely consistent with Keynes. All that stuff about pissing money at bureaucrats only comes *after* you\’ve pushed all of the monetary buttons.
Anyway, moving on from Willy\’s misconceptions, here\’s my prediction for what they\’re likely to be saying about now in 30 years\’ time.
Yes, it\’s still monetary, yes, we do need to make sure that the money supply can and will expand. And yes, the BoE and the Fed are doing their best….except for one point. And I\’m really very surprised at the people who are missing it.
It\’s the usual lefty whine that it\’s the banks that create credit. Which is true, that it\’s the banking system which does so (not \”a bank\” but \”banks\”). Credit is of course part of that money supply (sorry, too bored to look up by which measure. Cash is M0, bankd deposits and loans etc are M3 or M4?). OK, we can keep feeding M0 or M1 whatever into the system but what we\’re really interested in is what is the effect of that on M3 (or M4?)?
For that\’s the form of he money supply that is actually important for that real economy.
OK, so, what is the limitation on how M1 gets transformed into M3? Err, the banks, no? Specifically, how much credit can they create from whatever lower M is pumped in?
Something which is determined (at least in part) by the capital ratios that we insist the banks have. The higher the capital ratio we demand, for preautionary purposes, the less M3/M4 there will be for any given stock of M0/M1.
What are we currently doing with the banks? Insisting that they double their capital ratios no? Tier 1 capital requirements are being increased from 4% ish to 8% ish?
So that\’s my prediction. That there will be some monetary economist in a few decades time who points out the seemingly obvious. That it\’s insane to be whining about shrinking credit, a falling money supply, when you\’re deliberately shrinking credit, that money supply, by insisting upon higher capital ratios for the banks.
I agree, we might well want for other reasons for the banks to have those higher capital ratios. But then economics is always about trade offs: there are no solutions.