Wednesday, November 14, 2012

Charlie Bean’s three mistakes.

Charlie Bean is deputy governor for monetary policy at the Bank of England. In this recent speech he makes three mistakes (not something I ever do, of course).
First, he trots out a piece of conventional wisdom, namely that banks should be safe enough to reduce risks to acceptable levels, while not ending up with the stability of the graveyard. In his words he wants to ensure the “resilience of the financial system in a way that does not unduly impede economic growth.”
Well now, would reducing the risk of bank failure to near zero actually impede economic growth? Certainly not. At least not if we adopt the banking regime advocated by Positive Money / Richard Werner and the New Economics Foundation. See here.
Under that regime, the loans and investments made by banks are 100% covered by loss absorbing creditors (of each bank). In particular, depositors who want interest, i.e. who want their bank to lend on or invest their money carry the costs if and when those loans or investments go bad. That way, the bank itself cannot fail (absent blatant criminality by senior bank staff).
Now does that impede that much vaunted “economic growth”? Far from it! It actually results in a better allocation of resources and for the following very simple reason.
If someone invests directly in a small business or in corporation X, Y or Z on the stock exchange and it all goes belly up, the investor takes a hit, or may lose everything. But if the same investor plonks money in a bank and the bank invests in or lends to small businesses or corporations X, Y, Z, etc and it goes belly up, the taxpayer comes to the rescue for some bizarre reason.
That is a TOTALLY UNWARRANTED AND IRRATIONAL subsidy for banks. It is a distortion of the market. It’s a misallocation of resources. And any misallocation of resources hits economic growth.
Conclusion: far from bank safety and economic growth being in any way mutually exclusive, virtual 100% bank safety (done the above way) actually ENHANCES economic growth.

The second mistake.
Bean’s second very questionable claim (p.3) is that central banks can forsee credit crunches and should act to ameliorate them before the event. Now that idea is straight out of cloud cuckoo land.
What proportion of “professional” economists foresaw the recent crisis? 1%? Or was it nearer 0.1%?

The third mistake.
Next, Bean claims that with a view to ameliorating crises, a central bank should “undershoot its inflation target temporarily, if it believes that it will thereby improve its chances of meeting the target later on by avoiding a disruptive bust.” (This of course assumes that central banks really can foresee crises.)
Now “undershoot it’s inflation target” is weasel words for “impose a mini-recession and excess unemployment”. And that’s not too clever – unless there’s no alternative.
But there is a blindingly obvious and very simple alternative! That’s to counteract the recessionary effect of raised interest rates with fiscal stimulus. Simple. That way a country gets less lending based economic activity and more non-lending based activity.


Thanks to Gary Brooks for bringing the above Bean article to my attention.

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