Can policy ever control the credit cycle?
The Bank of England will soon be in charge not only of the UK's monetary policy but also its financial stability and its banking system, both of which involve macro-prudential regulation.
Tonight the bank's financial stability chief Andrew Haldane has given a speech at Columbia University, NYC outlining the Bank's latest work on modelling the credit cycle (with Aikman D and Nelson B). See Bank of England website.
Haldane et al argue: self-regulation is not enough to curb the credit cycle; therefore the state needs to intervene to depress lending during a boom: monetary policy is not enough to achieve this, and indeed may be counter-productive, because if the credit boom is an excrescence on a fairly modestly growing real economy, monetary intervention can needlessly flatten growth.
"systematic, across-the-system actions are needed to curtail effectively credit booms and busts"
Two things follow from this: there needs to be internationally co-ordinated macro-prudential action (as signalled at Pittsburgh) and the "regulatory boundary" has to be moved so that the so-called shadow banking system, which is now as big as the official system, is brought under macro-prudential regulation.
This has massive implications. It means the Bank of England is going to, quite soon, set about trying to flatten out the credit cycle, with tools that are untested and on a system whose genetic predisposition to regulation is flight, escape, denial, resistance.
And then try and block the escape mechanism.
To get a sense of the complexity of the escape mechanism - aka shadow banking - have a look at this poster produced by the New York Fed (hat tip to Gillian Tett inside the FT's firewall for this). It looks like the wire-diagram of the Star Ship Enterprise's matter/anti-matter assembly.
I would like to know not just how the Bank proposes to bring the shadow banking system into macro regulation.
I would also like to know Haldane et al's prediction as to what will happen to the credit cycle should this prove impossible to do. One logical conclusion would be that the credit cycle is uncontrollable. Indeed a graph in the Haldane et al paper (top of this page) shows it to be relatively immune to policy since financial capital emerged in the 1870s.
"The state of macro-prudential policy today has many similarities with the state of monetary policy just after the second world war. Data is incomplete, theory patchy, policy experience negligible. Monetary policy then was conducted by trial and error. The same will be true of macro- prudential policy now. Mistakes will be made. But as experience with the other arms of macroeconomic policy has taught us, the biggest mistake would be not to try."
Haldane's intervention follows Mervyn King's Buttonwood, New York speech where he thought aloud, loudly, about a Glass Steagall solution for British banking. Like the 19th century master of Oundle School, FW Sanderson, Britain's central bankers have decided to "think in a spacious way; think on a grand scale".
The problem is spacious thinking - given the scale of the challenge - leaves open a lot more questions than it answers. Newsnight stands ready to ask those questions should Britain's central bankers decide one day to start giving press interviews as well as lectures in New York.