A few things I read elsewhere

Just a quick few points today.

Scott Sumner has a few posts on whether or not growth is inflationary. He says:

If NGDP growth rose by 4%, and both RGDP growth and inflation rose by 2%, it would look like growth was inflationary. But in fact the NGDP growth (i.e. monetary policy) was causing 4% higher inflation, ceteris paribus, and the extra 2% RGDP growth was holding down the inflation rate, limiting the increase in inflation to 2%.

If this is the way the world works then one might expect many cognitive illusions to form. People would think growth was inflationary, whereas in fact it would be deflationary, as the regression in the previous post showed, and as our theoretical model predicts. Procyclical inflation would reflect bad monetary policy (unstable NGDP growth) and inflation would be strongly countercyclical under a sound monetary policy regime (stable NGDP growth.) If the central bank predicts that inflation will pick up during a boom period, they are predicting their own incompetence.

THIS.

I have grown tired over the past few years of economists, analysts and journalists predicting that inflation would be back because RGDP growth was coming back.

I missed another very confusing post by Izabella Kaminska (referring to a blog post by Peter Stella) a few days ago about ‘hyper liquidity’. To make it short, I agree about the term ‘hyper liquid’, but the rest of the post seems to be way off the mark. I say ‘seems’, because I’m really unsure I understand what the h*ll she’s trying to say.

Can someone translate this for me please:

As Stella notes, this is why the common conception that banks lend reserves “out” to non-banks is simply nonsense. Reserves are not for lending. At best they’re part of a penalty system, representing the amount of value/capital that needs to be withheld to protect the system from bad agents. It’s a cover. Insurance.

Indeed, re-lending reserves would defy the point of holding reserves in the first place.

What banks actually lend out is credit.

Credit represents a guarantee that the bearer of a bank’s coupons (who has been vetted) will not squander the assets/goods provided to him, but work to replace them in a meaningful value-adding way which grows the system as a whole rather than contracts it.

That doesn’t mean funding isn’t important! It is hugely important. We simply mustn’t confuse funding for something it isn’t. When a bank’s credit is well funded (so, the new assets it creates through lending), this means the current coupons (liabilities) it issues to the borrower for use in the real economy are guaranteed to square with what the system has available for sale within that timeframe. The funding represents a “store of anything to be drawn upon.” Funding can and is relent. But it’s what a bank doesn’t lend out, but keeps in its own reserve at an opportunity cost to itself, which counts as a bank capital reserve. It’s pre-funding.

When banks issue unfunded liabilities, there is no guarantee that the system is able to service them. Thus, there may be inflationary consequences.

The whole thing doesn’t make any sense to me, from an accounting or an economic point of view. Apparently, funding can be relent, but what is not relent is a capital reserve, which is pre-funding. Wait… what? I really don’t get it. Perhaps I just need holidays.

The assumption in the post that the bank reserve system is ‘closed’ is simply wrong. Reserves leak all the time, at least through deposit withdrawal (you don’t withdraw credit at the ATM. You withdraw high-powered money, deducted from the bank’s reserve account at the central bank). Stella (and possibly Kaminska) also seems to forget that it can take many decades for the money multiplier to recover. Banks don’t really lend out reserves: they extend credit on top of those reserves. Hence the money multiplier. And this funding/pre-funding/re-funding/asset funding/capital funding/ultra funding/turbo funding story is just crazy.

Finally, in light of my fights against Basel’s RWAs, I stumbled upon the following very relevant quote from F.A. Hayek:

The contention often advanced that certain political measures were inevitable has a curious double aspect. With regards to developments that are approved by those who employ this argument, it is readily accepted and used in justification of the actions. But when developments take an undesirable turn, the suggestion that this is not the effect of circumstances beyond our control, but the necessary consequence of our earlier decisions, is rejected with scorn.

This perfectly fits the RWAs example. Well-meaning regulators came up with a system that would reduce the accumulation of risk in our banking system. Events didn’t turn the way they expected, but it wasn’t the fault of the original rules of course (even if they massively favoured real estate lending over corporate lending). But don’t worry citizen: they are working on making those rules even better. See the result on this brand new chart from the WSJ:

We already knew that all residential property markets were cooling down all around the world. Now it looks like the CRE market is also calming down. The new rules are indeed working. Good job folks!*

*I hope you got the irony