In my recent post Game Theory: Rajan vs. Government, we saw how the ideal relationship between the central bank and the government is one where neither party gets what it wants, but there’s a stable outcome. Here are a bunch of articles that expands on the conundrum faced by a central bank.
Interest rate policy is a poor substitute for good regulation
“Monetary policy faces significant limitations as a tool to promote financial stability,” Ms. Yellen said in an event at the International Monetary Fund in Washington. “Its effects on financial vulnerabilities … are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment.”
Andy Haldane: Financial markets are nuts
Andy Haldane, the Bank of England’s chief economist, explains that central banks have “grown a new arm, macro-prudential regulation” to prevent the markets becoming over-egged with risk.
He cites the BoE announcing measures to prevent the housing market overheating, last week.
The financial markets today are nutty, but they’d be nuttier if central bankers hadn’t acted in the way they did since the collapse of Lehman Brothers.
Trilemmas breed instability
- A country can have a fixed exchange rate, free movement of capital or independent monetary policy, but not all three.
- Countries cannot simultaneously pursue democracy, national self-determination and economic globalisation.
- It is impossible to combine financial stability, internationalised finance and national sovereignty.
- Health systems have to choose among the “three Cs” — cost, coverage and choice.
There are very few “right” answers. All policy decisions involve trade-offs. Different generations of politicians (and voters) will favour different solutions.
Source: Three’s a crowd