The problem with arguments about regulation is that they are the same in both directions:
In favour:
Look, obviously we need more regulations, you can tell because we didn't prevent this recession.
Against:
Look, obviously regulation don't work. You can tell because regulation didn't prevent this recession.
Everyone agrees that some financial regulation is desirable, efficient and effective. Unfortunately the world moves too quickly for regulation to effectively prevent recessions. I think its dangerous to pretend otherwise.
In so far as this recession has a cause, it is important to disaggregate the common factors. Firstly: what is a recession. I like Karl Smith's explanation of this, "a recession is when markets fail to clear", which means, essentially, that although we still have the capacity to make all the same stuff, but the prices aren't right so people are not buying.
A recession can have a variety of different causes, some have clear causes: the silver crises of the late eighteenth century, was caused by a shortage of the medium of exchange. In essence china ran a huge surplus and drained the silver currency out of Europe, creating deflationary pressure. Alternatively, sometimes `real shocks' can produce a recession. In these cases, normally caused by a shortage of a resource, the economy is badly wrong footed, and literally can no longer produce the same stuff that it could before. Such crises are normally associated with high inflation, which makes sense, as there is the same amount of money, but less stuff, so prices rise.
To understand a banking crises, we should understand that `money' is a broad and nebulous concept. For example, banks engage in `credit creation', by loaning money out, and as long as investors are happy that the loan will be repaid, they are often happy to treat the loan as a medium of exchange, and use it as an asset. In a banking crises there is a lack of confidence, and consequently investors will no longer treat loans or other securities as safe alternatives to cash. In our recession:
And you can see the collapse in the broad money aggregate caused by the banking crises. In practice, the decline shown here is more the fact that many of the securities' principle value, was that they could be used as collateral in repo transactions. Without that use, no one is buying them, and so there is less lending and this is what is showing up. This does not include the fact that the banks have on their balance sheets a massive number of financial instruments that they used to be able to use to raise liquidity, and in practice could treat exactly like cash, which are now effectively illiquid.
This narrative is sometimes called the `lack of safe assets'. Demand for assets that can still be traded as a medium of financial exchange is what is driving German, Us and Uk bonds into negative real interest rates. If I am a bank that needs to raise some cash quickly, or needs to provide a security deposit for a loan, these are essentially the only securities that are being accepted.
If this recession can be said to have a proximate cause then, it is that the sudden change in the perception of systemic risk has led to a collapse of the broad money aggregates. This has led a a broad deflationary pressure, which shows up in broken markets. Suddenly demand for cash by financial markets is effectively driving up the price of labour. It is this that has driven the labour market out of whack. The correct policy response is to provide enough liquidity by having the central bank replace these securities with things that can be treated as money aggregates. You can do this monetarily, by having the central bank simply create currency to buy these securities and give the banks cash instead. Alternatively you can do it fiscally, since running a large budget deficit is effectively equivalent to large scale credit creation. You will be producing large amounts of a safe asset that the financial markets will treat as a medium of exchange.
Central banks the world over should be attempting to create inflation, merely to balance the deflationary pressures of deleveraging. The fact that long dated treasuries are looking negative, is a sure sign that no one is expecting the central banks of the world to succeed in this, or even to attempt it, since its impossible for a central bank to attempt inflation and fail. I do not believe inflation will rear its head until the deleveraging is complete. In fact, even after that, printing money will only lead to inflation if, after the old securities are liquidated into cash, there is an appetite for new securities which are again seen as safe enough to be treated as cash. If this does not happen, or happens slowly, there will be plenty of time for the central bank to adjust the money supply so as to prevent inflation. I suspect risk appetite will only return slowly, but that is really only a guess about the future.
EDIT: perhaps I should also have made the point that in none of the other recessions on the graph did the money aggregates decline: declining money aggregates tend to be signatures of banking crises specifically.
The physics is theoretical, but the fun is real. - Sheldon Cooper
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kenberg, on 2012-May-09, 04:56, said:
