Worthwhile Canadian Initiative

Bad banks, and the effectiveness of fiscal and monetary policies

I'm going to take another crack at this topic. Do bad banks (and a bad financial system) reduce the effectiveness of fiscal and monetary policies in shifting the Aggregate Demand curve to the right? The answer matters, because if they do reduce the effectiveness of fiscal and monetary policy (a lot), then we need to fix the banks and financial system first. If not, then we shouldn't wait. Plus, using fiscal and monetary policy to shift the AD curve to the right might be one of the most effective ways to help fix banks and the financial system. The risk of deflation and depression is presumably one of the most important things making loans riskier.

What happened in 2001:1 ?

What happened in the first quarter of 2001 that would cause BOTH:

1. A US house price bubble?

AND

2. A structural change in relative prices between high-end and low-end US houses?

Short run "Speed Limits" on recovery

Mark Carney, Governor of the Bank of Canada, spoke yesterday about short run "speed limits" to economic recovery. This is a concept you don't hear very often, so I thought I would briefly discuss it. It's easily confused with the much more familiar long run "speed limits" to economic growth. And those long run "speed limits" aren't really speed limits; they are level limits.

Actually, I think the Governor's explanation slightly confuses those long and short run speed limits.

Banks, Aggregate Demand, and Aggregate Supply

What is the relation between banks, aggregate demand, and aggregate supply? Do bad banks shift the AD curve or the AS curve? Do bad banks make it harder for fiscal or monetary policy to shift the AD curve?

Some economists argue that you need to fix the banks (and the financial system) to get an economic recovery; fiscal or monetary policy alone won't do it. I wish people who made that argument would be more clear on where they see banks fitting into the AD and AS framework. Keiichiro Kobayashi for example argues that Paul Krugman puts too much emphasis on fiscal policy rather than fixing bad banks; he argues that fixing the banking system is a necessary condition for recovery, and fiscal policy alone won't work.

Canadian vs. US bank regulation?

This is a topic I do not understand at all well, but I am confident that some of our readers will. But I do hear that the myth that Canadian banks are more strictly regulated is largely...well, a myth. One colleague who used to work in banking told me he never actually met a regulator, there are so few. It's more a difference in style, or method? Our US readers might also be interested in the comparison.

This article by Tara Perkins in the Globe and Mail caught my eye. Here's an excerpt:

Mechanical metaphors for monetary policy

This is a post for people who find mechanical metaphors useful. And remember, any theory that can be translated into math and put on a computer (even if it doesn't need to be) has a mechanical counterpart, because a computer is a machine.

I am going to use mechanical metaphors to think about different monetary policy control instruments. "Quantitative easing", if you like.

The Bank of Canada says: "Quantitative easing if necessary, but not necessarily quantitative easing"

The Bank of Canada released its eagerly-anticipated Monetary Policy Report (pdf) today, in which it laid out its contingency plans for quantitative easing. But it seems pretty clear that - notwithstanding its jaw-dropping estimate of annualised 2008Q1 GDP of growth of -7.3% - it doesn't intend to be implementing those plans anytime soon.

Here's why:

Panic as fiscal stimulus

I guess this is what happens when people start building survival shelters and stocking up on canned goods:

Retail sales edge higher in February: Canadian retail sales rose unexpectedly in February, led by home supplies, and food and beverage stores.

Zero (effectively, finally); What Next for the Bank of Canada?

So, the Bank of Canada has finally cut the overnight rate target to 0.25%, which is as low as it feels technically able to go, so is effectively zero, by its reckoning. I'm not going to discuss those technical issues on the problems with 0.00% vs. 0.25%, because it's not my comparative advantage. But this TD Economics report seems useful, if you are interested.

An alternative universe with gold price control

Imagine you are a monetary economist, working in a central bank, and you wake up one morning and find yourself in an alternative universe. You don't realise it's an alternative universe at first, because everything looks the same. But when you get into work and go to the meeting of the monetary policy committee, you realise something is very different.

You are the first to give your views. You discuss all the various indicators, like inflation, unemployment, commodity prices, and give your recommendation for the overnight rate target (Feds fund rate, if you like) for the next 6 weeks, needed to keep future CPI inflation on target. The response is not what you expect. They all look at you like you're crazy. Then someone mentions that it's April 1st, and they all start laughing.

The second person to speak discusses all the same indicators you did, with two exceptions. She leaves the price of gold out of the list of commodity prices. And she adds the overnight rate of interest to the list of indicators. Then the bombshell: she gives a recommendation for the gold price target for the next 6 weeks, needed to keep future CPI inflation on target.

You then realise you are in an alternative universe (plus, she's got orange eyes).