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Adam Posen calls for more QE – that’s fine, but…

Adam Posen who sits on the Bank of England’s Monetary Policy Committee (MPC) has a comment in on New York Times’ website.

Adam Posen is known to favour aggressive quantitatively easing in the present situation and in his piece he argues strongly that both the ECB and the Federal Reserve should follow the lead from the BoE and step up aggressive QE.

Posen rightly criticize the Fed, the BoE and the ECB with being too reluctant to do the “right thing” and in many ways his comments resembles my own critique of policy makers as being “Calvinist” in their thinking.

Posen is also right in arguing that more definitely is needed in both Europe and the US in terms of easing monetary conditions, but I have often argued that Market Monetarists are not in favour of discretionary policies (See here and here). We want to see QE within a proper framework of NGDP level targeting and not discretionary monetary “stunts”. The experience with both QE1 and QE2 in the US shows that unless is anchored within a proper framework then the impact on NGDP expectations are likely to be relatively short-lived.

I think that there might be some disagreement among Market Monetarists here and I guess that for example Scott Sumner would be happy to take whatever we can get, while I personally is more skeptical. If QE is done in an ad hoc fashion outside of a clearly defined policy framework then I fear it will undermine the longer-term arguments for NGDP level targeting. Some are already arguing that QE did not work – I think QE works very well if it is done within a proper framework, but how can we convince the skeptics?

That does of course not mean that I would vote against more QE if I for example was on the BoE’s MPC or the FOMC (there is no chance that will ever happen…). And it is quite obvious that the ECB need to ease monetary policy right now and rather aggressively – even within ECB’s present framework.

Anthony Evans seem to share my concerns about QE without a proper framework. See Anthony’s comment here and here.

See also Marcus Nunes and Scott Sumner on Adam Posen’s comment.

PS Theoretically I also disagree quite a bit with Posen as it seems like he think that the monetary transmission mechanism works primarily via lower bond yields. It’s basic MM knowledge that successful monetary easing (increased NGDP expectations) will increase bond yields. See my previous comment the transmission mechanism here. Even though I am skeptical about Posen’s call for ad hoc monetary easing I in fact think that monetary policy with the help of the Chuck Norris Effect is much more powerful than Posen seems to think.

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“Global Banking Glut and Loan Risk Premium”

David Levey has sent me a new paper by Princeton University economics professor Hyun Song Shin on “Global Banking Glut and Loan Risk Premium“. I have unfortunately not had the time to read the paper yet, but it looks quite interesting and I would like to share it with my readers.

Here is the abstract:

“European global banks intermediating US dollar funds are important in influencing credit conditions in the United States. US dollar-denominated assets of banks outside the US are comparable in size to the total assets of the US commercial bank sector, but the large gross cross-border positions are masked by the netting out of the gross assets and liabilities. As a consequence, current account imbalances do not reflect the influence of gross capital flows on US financial conditions. This paper pieces together evidence from a global flow of funds analysis, and develops a theoretical model linking global banks and US loan risk premiums. The culprit for the easy credit conditions in the United States up to 2007 may have been the “Global Banking Glut” rather than the “Global Savings Glut””

Overall, I think the global financial linkages are extremely important in understanding how the Great Recession has played out and Hyun Song Shin’s paper could help us understand these linkages. I am personally very interested in the impact of the European banking sector’s demand for dollar.

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PS While the European crisis continues relentlessly it is hard to find anything positive of cheer you up. However, my colleague Antero Atilla – who long ago has realised that I am obsessed with monetary policy suggested a more fun youtube link today…have a look – it is all about money!

PPS The European crisis, business traveling and a bad flu is likely to keep me a bit away from blogging in the coming days.

Tilford and Whyte on the euro crisis

Simon Tilford and Philip Whyte have written an essay – Why stricter rules threaten the eurozone” – on the euro crisis for the normally strongly pro-European Centre for European Reform. I far from agree with everything in the report, but it is worth a read.

Here is the conclusion (for the lazy):

“When the euro was launched, critics worried that it was inherently unstable because it was institutionally incomplete. A monetary union, they argued, could not work outside a fiscal (and hence a political) union. Proponents of the euro, by contrast, believed that a currency union could survive without a fiscal union provided it was held together by rules to which its member-states adhered. If, however, a rules-based system proved insufficient to keep the monetary union together, many supporters assumed (as faithful disciples of Jean Monnet) that the resulting crisis would compel politicians to take steps towards greater fiscal union.

Initially, proponents of the euro seemed to have been vindicated. The euro enjoyed a remarkably uneventful birth, and a superficially blissful childhood. But its adolescence has been more troubled, lending increasing weight to the euro’s critics. If anything, a shared currency outside a fiscal union has turned out to be even less stable than the critics imagined. Common fiscal rules did not guarantee the stability of the system – not just (as North European politicians like to claim) because they were broken, but also because they were inadequate. The eurozone now faces an existential crisis – and EU politicians their ‘Monnet moment’. At root, the eurozone’s sovereign debt crisis is a crisis of politics and democracy. It is clear that the eurozone will remain an unstable, crisis-prone arrangement unless critical steps are taken to place it on a more sustainable institutional footing. But it is equally clear that European politicians have no democratic mandate in the short term to take the steps required. The reason is that greater fiscal integration would turn the eurozone into the very thing that politicians said it would never be: a ‘transfer union’, with joint debt issuance and greater control from the centre over tax and spending policy in the member-states.

Eurozone leaders now face a choice between two unpalatable alternatives. Either they accept that the eurozone is institutionally flawed and do what is necessary to turn it into a more stable arrangement. This will require some of them to go beyond what their voters seem prepared to allow, and to accept that a certain amount of ‘rule-breaking’ is necessary in the short term if the eurozone is to survive intact. Or they can stick to the fiction that confidence can be restored by the adoption (and enforcement) of tougher rules. This option will condemn the eurozone to selfdefeating policies that hasten defaults, contagion and eventual break-up. If the eurozone is to avoid the second of these scenarios, a certain number of things need to happen. In the short term, the ECB must insulate Italy and Spain from contagion by announcing that it will intervene to buy as much of their debt as necessary. In the longer term, however, the future of the euro hinges on the participating economies agreeing at least four things: mutualising the issuance of their debt; adopting a pan-European bank deposit insurance scheme; pursuing macroeconomic policies that encourage growth, rather than stifle it (including symmetric action to narrow trade imbalances); and lowering residual barriers to factor mobility.”

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