February 04, 2016

How could central bankers, and Martin Wolf, convince us (me) they know what they are doing?

Sir, Martin Wolf asks: “What might central banks do if the next recession hits while interest rates were still far below pre-2008 levels?” And he answers, “the most important part of such preparation is to convince the public that they know what to do.” “Prepare for the next recession”, February 5.

Not an easy task. For example I have always felt more uneasy with what banks might ex ante consider safe, than with what they could perceive as risky. But regulators, with Basel II, introduced risk weighted capital requirements for banks in which they for instance assigned a risk weight of 150 percent to assets rated as ‘highly speculative’ below BB-, while only a meager 20 percent risk weight for ‘prime’ AAA rated assets.

That not only seriously distorted the allocation of bank credit to the real economy but also set up banks for, when any ex post credit risk realities could sink in, that they stand there with little equity to cover themselves up with.

But seemingly there is no way I can convince central bankers, regulators, or Martin Wolf, that is a dangerous nonsense and so, at least in my view, I am convinced they do not know what they are doing.

Wolf also comments on the notion that doing nothing, searching for a “cleansing depression” is “crazy, given the damage it would do to the social fabric”. I am not sure. In August 2006, FT, before I was censored, published a letter I wrote titled “Long term benefits of a hard landing” and nothing about the many efforts to achieve a soft landing I have seen, have really made me change my mind.

@PerKurowski ©