Monetary Policy: Pushing on a String

The Bank of Canada today announced what appeared to be a dramatic cut (witness the splashy headlines) in the target for the overnight rate — a 50 basis point reduction. Bank of Canada to the rescue? Think again. The move was greeted with yawns from the banking community, which lowered mortgage rates by a mere 25 basis points.

I’m surprised they went that far.

When hoarding cash is de rigueur and panic is thick in the air, the banks have little incentive to lower their mortgage rates because they’re fearful of lending to anyone, even supposedly credit-worthy borrowers like, say, other banks in our supposedly “sound” banking system (Exhbit A:  the Bank of Canada recent efforts to expand the list of acceptable collateral for overnight loans and stabilize the overnight rate closer to its target).  In effect, we’re seeing the reverse of what happened in the lead-up to this debacle, where anyone who could sign his or her name qualified for a 40-year no-downpayment mortgage.

Besides, why lend money when you can earn profits by squeezing clients — especially your most vulnerable clients — in other, less obvious ways like shortening the interest-free period on credit card debt (see my previous post on this)?

So what can the Bank of Canada do that might actually calm things down? They can and should follow some of the advice been proffered by people like Warren Mosler, who forget more about monetary policy than most economists understand in a lifetime.

Top of the list?

Quoting Mosler, the monetary authorities (in the U.S. but sames goes for Canada) need to : “lend unsecured to any member bank in unlimited quantities and set term as well as ff (interbank, overnight)  borrowing rates.”  According to Mosler, “this will normalize bank liquidity, and should have been done as soon as we went off the gold standard…”

Our central bank should also be paying attention and doing what it takes to avoid a collapse of the Euro, a very real possibility and one that a good number of post-keynesian economists predicted was likely when the union was first put in place (the European Union has this strange divorce of fiscal, monetary policy and democratic sovereignty, one that history shows does not hold up well in a crisis of confidence).

That said, even these actions are insufficient to arrest the problem here and abroad. The real important message in today’s monetary policy non-event is how silly it is to put all our faith in monetary policy — to push against the proverbial string — when we have another tremendously powerful tool called fiscal policy that needs to do most of the heavy lifting.

But to do that, we need to overcome our fear of deficits and more than 20 years of policy practice that has left responsibility for all the heavy macro-economic lifting in the hands of the Bank of Canada.  And that, my friends, is the subject of my next post.