Cardiff Garcia has a great post about safe assets and the quest for collateral. In the end he asks
Does the shadow banking system’s relationship to monetary policy have any implication for the Smithian/neo-Wicksellian view, which awaits the natural rate of interest imminently rising to and exceeding the federal funds rate?
The short-short-short answer is that from the looks of it right now the real economy driving the natural rate up will outrun the collateral contraction.
The short-short answer is that I will admit I am growingly concerned about what happens when we cross over to the other side. I have not looked into the details but from a 30K foot view I imagine that we will soon hit a point where the issuance of private safe collateral reverses, which could push some part of the economy into an uncontrollable boom.
My baseline expectation is that there is a non-trivial chance it could be housing all over again. Though again, I don’t know the details of the market.
In any case it’s a pickle because the fundamental asset problem remains and there is no clear way to stop the boom-bust cycle when private collateral is so strongly pro-cyclical.
As I hinted at, at Kauffman the ideal strategy would be for the US government to run massive deficit – most efficiently by dramatically reducing taxation at all levels and transferring the burden for Medicaid and Higher Ed to the Federal government and the massively opening up to immigration.
Thus allows us to support the issuance of massively more public collateral and have it backed by a larger population. Absent something like this I think there is no obvious way to avoid this.
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Friday ~ April 6th, 2012 at 12:23 pm
Axel
Isn’t there any options which would help deflate the overall shadow banking system instead of reflating it ?
We could try to replace shadow money with monetary base and put a lid on private collateral use via regulation like minimum haircuts/max-LTV on the demand side and on the supply side forcing bank to put same capital amount in front of secured credit than in front of unsecured when representing more than xx% of total Loans/Equity ?
By the way, there is no reason why public debt should always be a safe collateral, hence never ever being pro-cyclical for the shadow banking system. Collateral risk perception does not rely on ranking of assets quality but absolute assessment of asset quality. Therefore you might be forced into full blown monetization at the end such a game.
Hopefully the kick will come before we have to test that kind of problem, but it seems from what you say that SBS monetary policy is far more costly than ‘traditional’ monetary policy.
Friday ~ April 6th, 2012 at 12:43 pm
Morgan Warstler
why is this true:
“And yes, that does lead to an argument against tightening fiscal policy too quickly: fiscal consolidation tightens monetary policy also.”
and then this:
“How to define, for instance, the appropriate coordination between the central bank and fiscal policymakers when the outstanding Treasury stock affects monetary policy in this way?”
If Ben tells Congress they have to cut spending now and in the future and don’t worry, he’ll keep NGDPLT running at 4.5%, it’ll piss off DeKrugman, but the policy is totally doable, no?
The very best part about 100% rule based NGDLT is that it silences those who scream fiscal cuts will slow the economy down.
The second best part is that it makes people angry enough when the public sector grows to keep it from growing.