Are Central Banks Inflating Themselves Out of A Job?
For a long time, we have questioned what central banks have done in response to crisis. To really get this, lets take a step back and take a close look at what they have done.
Central bankers operate under one fundamental tenet—that an economy must expand. Sure, “price stability” is commonly cited as a goal or mandate of central banks. But let’s be honest—if you look at the last 100 years, the prices of things have not been stable at all—they have consistently risen to balance an expanding supply of paper.
Over the last few years, central banks have responded to financial lock-up by lowering interest rates. This has two basic effects. Firstly, it makes it cheaper for us to borrow to consume now—which buoys the economy. But secondly, if you were saving, you would quickly realize that your savings are earning less interest—and if you spent instead of saving, you wouldn't really lose that much. In economic nerd-speak—the opportunity cost of spending goes down.
So what is wrong with this picture? Well, in basic terms—there is no way that creating an endless supply of credit will create an endless amount prosperity—that’s not the way things work.
In today’s Financial Times, Bill Gross, PIMCO’s CIO, makes the same case, arguing that central banks aren’t just “pushing on a string,” they’re actually damaging their own economies.
Historically, central banks have comfortably relied on a model which dictates that lower and lower yields will stimulate aggregate demand and, in the case of financial markets, drive asset purchases outward on the risk spectrum as investors seek to maintain higher returns. Near zero policy rates and a series of “quantitative easings” have temporarily succeeded in keeping asset markets and real economies afloat in the US, Europe, and even Japan. Now, with policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.
He then makes the case, in not so many words, that central banks are speeding up their own demise. By driving down interest rates, they are perverting the nature of risk-taking.
If an investor has money on deposit with an investment bank/broker that not only appears to be at risk but returns nothing, then why maintain the deposit? Perhaps an investor would be more comfortable with a $100 bill at home in a mattress than a $100 bill on deposit with a broker – Securities Investor Protection Corporation notwithstanding. If so, system wide delevering takes place as opposed to the credit extension historically necessary for an expanding economy.
What he is saying here is that central banks have created an environment where there are no longer safe havens in government bonds or even cash in the bank. Since the $100 under the mattress is safer than keeping it in a bank, central banks have essentially created a situation where bank runs are an imminent and natural part of the economy—so much for the idea of central banks saving their own.
Original source
Central bankers operate under one fundamental tenet—that an economy must expand. Sure, “price stability” is commonly cited as a goal or mandate of central banks. But let’s be honest—if you look at the last 100 years, the prices of things have not been stable at all—they have consistently risen to balance an expanding supply of paper.
Over the last few years, central banks have responded to financial lock-up by lowering interest rates. This has two basic effects. Firstly, it makes it cheaper for us to borrow to consume now—which buoys the economy. But secondly, if you were saving, you would quickly realize that your savings are earning less interest—and if you spent instead of saving, you wouldn't really lose that much. In economic nerd-speak—the opportunity cost of spending goes down.
So what is wrong with this picture? Well, in basic terms—there is no way that creating an endless supply of credit will create an endless amount prosperity—that’s not the way things work.
In today’s Financial Times, Bill Gross, PIMCO’s CIO, makes the same case, arguing that central banks aren’t just “pushing on a string,” they’re actually damaging their own economies.
Historically, central banks have comfortably relied on a model which dictates that lower and lower yields will stimulate aggregate demand and, in the case of financial markets, drive asset purchases outward on the risk spectrum as investors seek to maintain higher returns. Near zero policy rates and a series of “quantitative easings” have temporarily succeeded in keeping asset markets and real economies afloat in the US, Europe, and even Japan. Now, with policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.
He then makes the case, in not so many words, that central banks are speeding up their own demise. By driving down interest rates, they are perverting the nature of risk-taking.
If an investor has money on deposit with an investment bank/broker that not only appears to be at risk but returns nothing, then why maintain the deposit? Perhaps an investor would be more comfortable with a $100 bill at home in a mattress than a $100 bill on deposit with a broker – Securities Investor Protection Corporation notwithstanding. If so, system wide delevering takes place as opposed to the credit extension historically necessary for an expanding economy.
What he is saying here is that central banks have created an environment where there are no longer safe havens in government bonds or even cash in the bank. Since the $100 under the mattress is safer than keeping it in a bank, central banks have essentially created a situation where bank runs are an imminent and natural part of the economy—so much for the idea of central banks saving their own.
Original source
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