Dilution-based monetary transmission November 2, 2012 at 8:17 am

From the Economist:

In Britain, the monetary base is 334% higher than it was six years ago, reserves at the central bank are 909% higher but broad money is only up 47% and bank lending to the private sector has risen just 31%, In other words, the money multiplier has collapsed.

So how can central banks encourage commercial bank lending?

Charles Goodhart has an interesting suggestion: any bank which failed to increase lending by a certain percentage would be forced to issue equity to the government, a kind of backdoor nationalisation. Nice.

6 Responses to “Dilution-based monetary transmission”

  1. Why? This is all based on the notion there is rampant unrequited demand for bank credit in the real economy and that more bank capital will solve the supply problem. I just don’t see that. In this respect funding for lending will be a good experiment given how it waives pillar 2 capital requirements on New fls lending.

  2. We’ll see – you might be right, and worse you might be wrong and meeting the demand just causes another asset price bubble but – whatever the outcome – we do need to fix monetary transmission.

  3. I do agree with you the trans mech needs fixing. Monetary policy is at its limit and has been forced far closer to fiscal policy than anyone could have imagined 5 years ago. I do wonder whether the transmission would be better if the debt overhang was targeted directly by fiscal policy, ie restructuring private sector debts. But it’s weird / depressing that politicians seem less keen on fiscal policy radicalism than monetary radicalism.

  4. The suggestion is more likely to lead to banks working around the rule (eg lend to rule compliant entities that just safely park the money in gilts in exchange of a small admin fee). If the government wants more lending than private banks are willing to do, it can have the central bank or an agent lend directly. They can do that without picking winners with formulaic matched funding if so preferred.

    As for “fixing” monetary transmission, has it ever really worked that well? At some point it may be wiser to admit that the interest rate channel is too blunt and imprecise to deserve its role as the main monetary policy instrument.

  5. Indeed, the “money multiplier” collapsed; in the US as well. However, I am amazed that it would be “nice” to punish institutions (and the capital that supports them) for responding to 1) the new regulatory regimes and 2) the realities of the current market. And, as an earlier commentator stated, such a rule would likely generate more energy devoted to avoiding the penalty than meeting the spirit of the reg.

    Perhaps a more fruitful approach would be to examine why the current extreme expansionary measures have not resulted in the expected Pavlovian response. I worked through five recessions in my career and clearly recall that banks go into survival mode during the bad ones, cutting back all asset intense businesses regardless of profit opportunity. In severe recessions it is all about having a better CAR, no matter how defined, in the approaching quarter. This reaction is one reason why shadow banks have increased market share.

  6. It is nice to encourage banks to do what they are intended for – lend money to the real economy. If it takes an incentive like Buiter’s to do that, then so be it.