Friday, September 6, 2013

My, what big words you use

Jeffrey Chwieroth and Jon Danielsson of the London School of Economics say;
Since 2007, central banks have been increasingly tasked with developing and deploying macroprudential policy tools aimed at limiting the buildup and consequences of systemic financial risk.
This means that the relevant authority, more often than not the central bank, has to monitor the economy and develop a toolkit for dealing with any threats. In practice, there are significant technical challenges, above and beyond those faced by the central bank a generation ago.
In fighting inflation, the central bank has one explicit tool at its disposal – interest rates – as well as an unambiguous and easily measured objective – inflation. There is no equivalence in macroprudential policy. Instead, the policymaker has at her disposal a wide-ranging collection of often conflicting tools and an even more baffling set of measures designed to capture systemic risk, financial instability, or the object of interest in the macroprudential agenda. This macroprudential ambiguity makes it difficult to build the necessary political consensus for employing the macroprudential toolkit.
If the above is supposed to be saying that central banks can conduct monetary policy, but not regulate banks and banking practices, fine. Valuable advice; stick to your knitting. However, the sentence in bold (courtesy of HSIB) is simply flat out wrong.

To take the latter point first, 'inflation' is not unambiguous and easily measured at all. As Scott Sumner makes a point of, constantly. For instance, the housing component--housing services--of America's Consumer Price Index told us that it was up 10%, at the same time (post 2008) the Case-Shiller Index said housing prices had declined 35%. There's also the difference between core inflation and headline inflation. As well as the known problems with valuing quality improvements or, even harder, new products.

But, the real bone to pick with the LSE fellas, has to be their idea about interest rates. They aren't a tool, they're prices. Prices pushed and pulled by many factors in addition to the central bank's open market operations--an actual tool. Which ambiguity makes interest rates a horrible indicator of monetary policy. As Milton Friedman was famous for pointing out.

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