This week, I’ve done a lot of reading, in the train and during my internship (I could write a book on what I wrote as well). As I came across many (I mean seriously a lot of) interesting papers, discussions, and other pieces, one thing especially caught my attention and this is what I’ll shortly write about. At least, I’ll try to keep it short. Keeping it short is not my strongest point (in writing that is, in words I find it so much easier to be short and concise).
Anyway, the results of the stress tests were published last Friday. I hope to write more on that next week, as I’m definitely curious about how the markets analysed the results during the weekend and how investors will respond to the failure of 7 banks during the stress test. My guess in earlier blogs was that publishing the results would not cause any stress nor any relief, simply because the scenarios tested were not strict enough. On the other hand, some banks appeared to have done some (mainly accounting) tricks and thereby made the results look much nicer. Slight chance that the markets take that to be something unimportant. The fact that banks performed those tricks is a very bad signal, but I could be wrong; perhaps the markets are relieved still (hmm right, like I’m ever wrong). We’ll know more tomorrow morning.
Now what I really would like to mention is the following.
This week, the IMF in a research bulletin discussed how monetary policy could and should be used to prevent increases in asset prices that are not sustainable (asset bubbles that is). A perfect example is the housing bubble that burst in the U.S. in the summer of 2007. Common thought –and the message of an important research paper by Ben (Bernanke)- before the financial crisis took off, was that tightening monetary policy is a too rude policy tool to avoid asset bubbles. Rather, the bubble should burst and it was supposed to be the role of monetary policy to clean up the mess afterwards, using a loose monetary policy to kick start the economy again.
Some months ago, I read a paper by three famous IMF-economists: Olivier Blanchard, Giovanni Dell’Ariccia and Paolo Mauro. In “Rethinking macroeconomic policy”, they wrote that we should learn from the current crisis and that we should use more direct policy tools to fix the problems at hand. As the Jan Tinbergen-rule goes: one target, one policy tool. So: monetary policy is used to target inflation. Fiscal policy is used to make redistributions and the automatic stabilisers of fiscal policy work countercyclical. A disregarded policy that can be used well to prevent asset bubbles is regulatory policy. And this sounds so simple (although I’m sure working out the exact details takes some more time), but collateral requirements, capital and liquidity charges, and stricter lending policies make banks hold more capital and prevent credit overexpansion or give banks some leverage such that they can overcome external shocks. An example is Spanish dynamical provisioning that builds buffers in good times that can be used in bad times, to put it bluntly.
For more details, I want to refer to the paper of Blanchard, Dell’Ariccia and Mauro, which is really clear, well written, and credible. For now, I’m just wondering why the IMF wrote that monetary policy should be used (carefully, but still) to attack asset bubbles. Why is it that they disregard in some way the paper I mentioned.
I mean, if other policy tools could ‘do the trick’; why bother using such a rough measure to try to achieve the same thing, while at the same time it could seriously undermine economic growth. To me, it is like bombing the house to kill the nasty fruit flies in the kitchen, because I think it are these fruit flies that cause the rotten peaches. (Likewise, asset bubbles are hard to identify.) Definitely I’ll regret bombing the house if it turns out that the peaches will become rotten also without the nasty fruit flies in the –now bombed- kitchen.
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