Tuesday, May 13, 2008
Pushing on a string
Ed Lotterman looks at the latest Senior Loan Officer survey from the Federal Reserve and sees credit crunch:
Axel Leijonhufvud argues that this moment brings to a close the debate over inflation targeting and central bank independence. On the former, we have long argued that a central bank has financial stability responsibilities, but holding down inflation is part of creating that stability. Leijonhufvud argues that the late Greenspan Fed was using inflation targeting; I think most observers would disagree. The weight on output in its implied Taylor Rule was greater than zero, if Greenspan even used it. On central bank independence, Leijonhufvud assumes that the political process is best for deciding whether debtors or creditors take the brunt of adjustment costs when deflating a bubble. I don't see why this is necessarily true; politics would not need to look at minimizing those costs.
You can lead a horse to water but you can't make it drink. Keep that in mind when reading how much the Fed has driven down interest rates. In finance, you can increase the amount of money available for lending, but you cannot force banks to make loans. That limits the broader effects of plentiful money on the economy as a whole.What Lotterman describes is the classic problem of "pushing on a string", that monetary policy works more quickly and surely when it reins in credit than when it tries to inject liquidity into the system. We've known this could happen from looking at interest rate spreads (see Krugman for example), but results like this from the survey are more damning:
About 55 percent of domestic banks�up from about 30 percent in the January survey�reported tightening lending standards on C&I loans to large and middle-market firms over the past three months. Significant majorities of respondents reported tightening price terms on C&I loans to these firms, and in particular, on net, about 70 percent of banks�up from about 45 percent in the January survey�indicated that they had increased spreads of loan rates over their cost of funds. In addition, smaller but significant net fractions of domestic banks reported tightening non-price-related terms on C&I loans to these firms over the past three months.San Fran Fed president Janet Yellen today is calling this a credit crunch in no uncertain terms.Regarding C&I loans to small firms, about 50 percent of domestic respondents reported tightening their lending standards on such loans over the survey period, compared with about 30 percent who reported doing so in the January survey. On net, about 65 percent of banks�up from about 40 percent in the January survey�also noted that they had increased spreads of C&I loan rates over their cost of funds for these firms. In addition, large net fractions of domestic respondents reported tightening other price-related terms, and smaller fractions tightened non-price-related terms on C&I loans to small firms.
Axel Leijonhufvud argues that this moment brings to a close the debate over inflation targeting and central bank independence. On the former, we have long argued that a central bank has financial stability responsibilities, but holding down inflation is part of creating that stability. Leijonhufvud argues that the late Greenspan Fed was using inflation targeting; I think most observers would disagree. The weight on output in its implied Taylor Rule was greater than zero, if Greenspan even used it. On central bank independence, Leijonhufvud assumes that the political process is best for deciding whether debtors or creditors take the brunt of adjustment costs when deflating a bubble. I don't see why this is necessarily true; politics would not need to look at minimizing those costs.
Labels: economics
