Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
Display:
  1. You have a bunch of borrowers.

  2. Some of those borrowers are not creditworthy on the basis of their expected future cash flow. Banks are not supposed to lend them money.

  3. Some of the otherwise creditworthy borrowers are unable to put up sufficient margin to cover the requirement. Banks are not supposed to lend to those, because the bank might be wrong about their future cash flow and needs an equity cushion to protect itself from that risk.

  4. Some of the otherwise well-capitalised and creditworthy borrowers will be unwilling to pay the rediscount rate plus the markup to cover the bank's costs (and dividends). They will not borrow.

Monetary policy, as traditionally practised, pretends that #1 works perfectly. Since #1 works perfectly by assumption, #2 is unnecessary (so we can allow no-money-down adjustable-rate mortgages without a hitch). It then focuses all of its efforts on #3, and attempts to control inflation by jacking up the rate so high that people refuse to borrow.

I argue, first, that the central bank should be spending more effort on safeguarding financial stability by making sure you don't get runs on certain asset classes (including the country's ForEx reserves), and much less on safeguarding the return on lazy money by keeping inflation low. And, second, that financial instability arises when borrowers are not creditworthy (regardless of whether that money is cheap or expensive), and not when borrowers are creditworthy (again, regardless of whether the money is cheap or expensive). It is therefore much more sensible to focus on making sure the financial sector can't lend to people who are not creditworthy than it is to fiddle with the interest rate at which lending takes place.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 12th, 2011 at 01:28:15 PM EST
[ Parent ]

Others have rated this comment as follows:

Display:

Occasional Series