January 11, 2013

There is no fiscal or monetary policy that can make up for bad and distortive bank regulations

Sir, Gillian Tett draws four quadrants by on one axis showing the private sector in a credit boom, and the public sector stimulating, and on the other axis the private sector deleveraging and the public sector also deleveraging, going for austerity, trying to rein in any inflation threats. 

And this tool makes it easy to understand that it is only in the quadrant where both the private sector and the public sector are deleveraging that the risk of a liquidity trap and deflation exists, and so, when there both “monetary policy and fiscal expansion must be stimulative, since loose money alone will not work”. And this Ms Tett does in “It’s time to embrace a new mental map of central banks” January 11.

Absolutely! But using the same methodology, and in this case including on one axis what is ex-ante perceived as absolutely safe, and what is perceived as risky, and on the other axis what ex-post turns out to be safe, and what turns out to be risky, one should also be able to understand that it is only the quadrant containing what was ex-ante perceived as absolutely safe and that ex-post turned out to be risky, that poses any major threat to the banks. 

And therefore one could conclude in that capital requirements for banks like the current ones, higher for what is perceived as risky and lower for what is perceived as absolutely safe, make no sense whatsoever and only distorts.

And so again, for the umpteenth time, let me repeat that it really doesn’t matter if you select the absolute correct fiscal and monetary policy if at the same time, by using loony and distortive bank regulations, you are going to impede these to work.