Thursday, October 20, 2011

Tighter bank regulation does NOT impede growth.

I’m getting tired of being told that tighter bank regulation impedes growth. The fallacies in this idea are as follows.

First, in the long run, economic growth is determined by improved technology (other things like educational standards being constant). Thus even if bank regulation is tighter than optimum, in the long run, the effect on economic growth is negligible.

Second, it is blindingly obvious that tighter regulation will reduce loans by banks to businesses, ALL ELSE EQUAL. In particular, if the sources of funding OTHER THAN loans from large banks are not expanded when funding from banks contracts as a result of tighter regulation, then obviously total funding for businesses will decline.
But there is no reason why funding from the alternative sources cannot be expanded! And this is easily done by the simply by expanding the money supply, or monetary base, to be more exact.

Those touchy feely “small and medium size enterprises” which politicians love to show concern for, are often funded in informal ways, e.g. by loans from friends and relatives. And another alternative is equity finance. These alternative methods of funding automatically become easier if the monetary base is expanded.

Moreover, given the extra aggregate demand that comes from expanding the base, (or indeed the extra demand that can be effected in other ways), businesses will be in a better position to pay the extra fees or interest that banks have to charge as a result of tighter regulation!!!! Doh!

Driving at high speed means higher fuel consumption, which boosts fuel sales, which in turn “boosts economic growth”. Is that an argument against speed limits on roads? I think not. I think the intelligent policy here is to try to design speed limits in such a way as to optimise the trade-off between numerous factors: environmental factors, the costs of treating those injured in road accidents, etc. If that restricts economic activity, then no problem: just boost the economy via the usual methods – interest rate reductions, budget deficits, QE, and so on. That will result in people spending less on fuel or treatment for car related injuries and more on other consumer goods. Is that a problem?


Afterhought, 1st Dec, 2011. Nice to see the Financial Times main front page story also pouring cold water on the idea that tighter bank regulation impedes growth a week or two after the above post.


No comments:

Post a Comment