Thursday, July 5, 2012

Banks as Pariahs

This here by Izabella Kaminska is by far my favorite blog post in a long while.  My hat's off.

I am going to try to supplement this loveliness with a very simple bottom line. In the world we're in right now, the banks are completely failing in their function as trasmittors of monetery policy. In fact, they have become pariahs on the real economy.
This is why monetary stimulus has been ineffective - because the CBs continue to work through the banking system, rather than through the real economy.
This is also why in order to be effective, the CBs need to avoid the banking system and inject money directly into household budgets via helicopter drops or what have you.
Finally, this is also why, in the absense of helicopter drops by the CBs, fiscal expansion (whether via tax cuts or boosted spending) will remain a more effective tool - because the state can return us to the state of scarcity of real resources relative to money in relatively short order. For those in doubt - see World War II.
I will go even further. With rate curves as flat as they are, much of the government debt in countries like U.S., UK, Japan and Germany has become entirely money like. Anything from cash to treasuries up to 2 years duration can be described as a "government obligation bearing zero nominal interest rate". Under these circumstances, the distinction between creation of money by the central banks and creation of additional debt instrument by the state is moot. The key question is solely whether this new "money" or "money-like debt" is actually exchanged for goods and services (i.e., invested in real economy).


  1. Hello Econ! I read your comments over at Money Illusion. You seem like a thoughtful guy and a nice change of pace from Sumner's hyer Monetarist faith.

    To return to a subject being debated over at MI what do you think of the ECB's move on IOR-does it have any benefit at all or is it actually going to discourage some market participants?

  2. Thanks for the comment and kind words. The answer, honestly, is that I don't really know. My instinct is that this will have no effect other than maybe to reduce the banks profits. But with the nominal yields on much of short term paper in Europe now negative - I am not sure there is a difference even to banks' profits: already they could not earn a carry by borrowing from ECB and investing in German paper without getting too much duration risk.

    As far as real economy goes, I'm with Hume in that money locked up in a box is money destroyed. Right now, money is generally being locked up in a box. CB can induce spending a bit, but I am also of a view that maybe they are not all powerful in this regard. If people can't be induced to spend, somebody has to step in and just do it.