In a 2015 paper Mr. Borio and colleagues examined 140 years of data from 38 countries and concluded that consumer-price deflation frequently coincides with healthy economic growth. If he’s right, central banks have spent years fighting disinflation or deflation when they shouldn’t have, and in the process they’ve endangered the economy more than they realize.
“By keeping interest rates very, very, very low,” he warns, “you are contributing to the buildup of risks in the financial system through excessive credit growth, through excessive increases in asset prices, that at some point have to correct themselves. So what you have is a financial boom that necessarily at some point will turn into a bust because things have to adjust.”
He describes this as a “pincer movement” in a working paper he wrote with several colleagues this year. On one hand, globalization and other (often benign) factors make it harder for central banks to gin up inflation by cutting interest rates. On the other hand, by slashing rates in pursuit of that hard-to-attain inflation target, they create imbalances in the financial system that lead to crises like the one in 2008.
It’s not that other economists are blind to financial instability. They’re just strangely unconcerned about it. “There are a number of proponents of secular stagnation who acknowledge, very explicitly, that low interest rates create problems for the future because they’re generating all these financial booms and busts,” Mr. Borio says. Yet they still believe central banks must set ultralow short-term rates to support economic growth—and if that destabilizes the financial system, it’s the will of the economic gods.
[---]
The financial panic caught experts by surprise because they had assumed that the financial system (and the economy as a whole) would, through the inscrutable workings of the invisible hand, find a sustainable balance of saving, investment, consumption and other variables independent of central-bank policies.
Mr. Borio, in contrast, can explain exactly where dangerous financial imbalances come from: the incentives policy makers accidentally create for bad decisions on Main Street about borrowing and investment. The misallocation of resources during the booms requires a prolonged and miserable process of reallocation during and after a recession.
We should expect any serious monetary theory to explain a financial crisis, Mr. Borio insists. The only time he sounds genuinely dismissive of conventional wisdom during our conversation is on this point: “You know, in many of these models, how do they explain the Great Financial Crisis? They explain it as a meteorite coming from nowhere—it’s an exogenous shock, it’s productivity that all of a sudden for some unexplained reason collapsed, or people all of a sudden decided to save more, but without an explanation. In my most cynical moments, I say ‘shocks’ are a measure of our ignorance, not a measure of our knowledge.”
[---]
Above all, “it’s important to be thinking of these things all the time.” Policy makers should keep a constantly watchful eye on financial conditions, not only in the depth of a crisis or the height of a worrisome bubble. The problem comes when “95% of the time you carry out your policy as if these factors didn’t matter, and then when you see that the economy is running red hot and you see obvious signs of financial imbalances, you start moving.”
- Why Central Bankers Missed the Crisis
“By keeping interest rates very, very, very low,” he warns, “you are contributing to the buildup of risks in the financial system through excessive credit growth, through excessive increases in asset prices, that at some point have to correct themselves. So what you have is a financial boom that necessarily at some point will turn into a bust because things have to adjust.”
He describes this as a “pincer movement” in a working paper he wrote with several colleagues this year. On one hand, globalization and other (often benign) factors make it harder for central banks to gin up inflation by cutting interest rates. On the other hand, by slashing rates in pursuit of that hard-to-attain inflation target, they create imbalances in the financial system that lead to crises like the one in 2008.
It’s not that other economists are blind to financial instability. They’re just strangely unconcerned about it. “There are a number of proponents of secular stagnation who acknowledge, very explicitly, that low interest rates create problems for the future because they’re generating all these financial booms and busts,” Mr. Borio says. Yet they still believe central banks must set ultralow short-term rates to support economic growth—and if that destabilizes the financial system, it’s the will of the economic gods.
[---]
The financial panic caught experts by surprise because they had assumed that the financial system (and the economy as a whole) would, through the inscrutable workings of the invisible hand, find a sustainable balance of saving, investment, consumption and other variables independent of central-bank policies.
Mr. Borio, in contrast, can explain exactly where dangerous financial imbalances come from: the incentives policy makers accidentally create for bad decisions on Main Street about borrowing and investment. The misallocation of resources during the booms requires a prolonged and miserable process of reallocation during and after a recession.
We should expect any serious monetary theory to explain a financial crisis, Mr. Borio insists. The only time he sounds genuinely dismissive of conventional wisdom during our conversation is on this point: “You know, in many of these models, how do they explain the Great Financial Crisis? They explain it as a meteorite coming from nowhere—it’s an exogenous shock, it’s productivity that all of a sudden for some unexplained reason collapsed, or people all of a sudden decided to save more, but without an explanation. In my most cynical moments, I say ‘shocks’ are a measure of our ignorance, not a measure of our knowledge.”
[---]
Above all, “it’s important to be thinking of these things all the time.” Policy makers should keep a constantly watchful eye on financial conditions, not only in the depth of a crisis or the height of a worrisome bubble. The problem comes when “95% of the time you carry out your policy as if these factors didn’t matter, and then when you see that the economy is running red hot and you see obvious signs of financial imbalances, you start moving.”
- Why Central Bankers Missed the Crisis
No comments:
Post a Comment