Delong: From Central Bank to Central Planning?
Brad Delong argues that "we still have not had enough central planning in finance." More particularly, he argues that the "Fed and the Treasury are walking down a road that ends with making the price of risk in financial markets, along with the price of liquidity, an administered price":
From central bank to central planning?, J. Bradford DeLong, Project Syndicate: For more than 170 years, it has been accepted doctrine that markets are not to be trusted when there is a liquidity squeeze. When the prices of even safe assets fall and interest rates climb to sky-high levels because traders and financiers collectively want more liquid assets than currently exist, it is simply not safe to let the market sort things out.
At such a time, central banks must step in and set the price of liquidity at a reasonable level – make it a centrally-planned and administered price – rather than let it swing free in response to private-sector supply and demand. This is the doctrine of "lender-of-last-resort."
For more than half that time – say, 85 years – it has been accepted doctrine that markets are also not to be trusted even in normal times, lest doing so lead to a liquidity squeeze or to an inflationary bubble. So, central banks must set the price of liquidity in the market day in and day out. ...
[A]s social democracy, government guideposts, and centralized planning waxed and waned elsewhere in the economy, social democracy in short-term finance went from strength to strength. First, central banks suspended the rules of the free market in liquidity squeezes. Then they set the price of liquidity as an administered price in normal times. Then they freed themselves of all but the lightest contact with their political masters: they became independent technocrats, a monetary priesthood that spoke in Delphic terms obscure to mere mortals.
The justification for this system was that it seemed to work well – or at least less badly than central banking that blindly adhered to the gold standard or no central banking at all. ...
But now it appears that, despite all this, we still have not had enough central planning in finance. For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market. And it is the price of risk that is the source of our current distress. ...
[T]he risk premia on non-Treasury assets have soared... And it is this rise in risk premia that threatens to send the global economy into a deep recession, and turn the financial markets from a spectacle of schadenfreude into a malign source of unemployment and idle factories worldwide. ...
The Treasury has asked for authority to purchase $700 billion of mortgages to get them off of the private sector’s books. Expanding the demand and reducing the supply of these risky assets is a way of manipulating their price. The Fed and the Treasury are walking down a road that ends with making the price of risk in financial markets, along with the price of liquidity, an administered price.
This was how central banking got started in the first place: letting the market and the market alone determine the price of liquidity was judged too costly for the businessmen who voted and the workers who could overthrow governments. Now it looks as though letting the market alone determine the price of risk is similarly being judged too costly for today’s voters and campaign contributors to bear.
Posted by Mark Thoma on Thursday, October 2, 2008 at 12:33 AM in Economics, Financial System, Monetary Policy, Regulation |
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