Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Buiter on the central banks

Willem Buiter’s paper at the Jackson Hole Symposium
castigating the major central banks of the world (and the Federal
Reserve in particular) is worth reading in full (144 pages) even if one
disagrees with what he has to say. I am surprised that as of today, I
still cannot find the symposium papers at the web site of the Kansas
Fed which organized the symposium, but the paper is available
in the public section of the website of the Wall Street Journal.

Some people have been mis-characterizing the paper as dogmatically
opposing central bank interventions on moral hazard grounds. That is
not the impression that I got by reading the paper. The paper does
accept that the central bank has to intervene in times of crises, but
Buiter does oppose the particular forms that this intervention has
taken.

Below are some interesting quotes from the paper:

  • A case can even be made for taking the setting of the official
    policy rate out of the central bank completely … the central bank is
    the only agency that can manage liquidity. It will also have to
    implement the official policy rate decision … But it does not have
    to make the official policy rate decision. The knowledge, skills and
    personal qualities for setting the official policy rate would seem to
    be sufficiently different from those required for effective liquidity
    management, that assigning both tasks to the same body or housing them
    in the same institution is not at all self-evident. … In the UK, the
    Governor of the Bank of England could be a member, or even the chair
    of the MPC, but need not be either. (p 36)
  • The deviations between the official policy rate and the overnight
    interbank rate that we observe for the Fed, the ECB and the Bank of
    England are the result of bizarre operating procedures – the
    vain pursuit by the central bank of the pipe dream of setting the
    price (the official policy rate) while imposing certain restrictions
    on the quantity (the reserves of the banking system and/or the amount
    of overnight liquidity provided) … Ideally, there would be a 24/7
    fixed rate tender at the official policy rate during a maintenance
    period, and a 24/7 unlimited deposit facility at the official policy
    rate. (p 37-8)
  • Libor now is the rate at which banks won’t engage in unsecured
    lending to each other. (p 25)
  • … those engaged in applied statistics should not leave their
    ears and eyes at home. Specifically, it pays to get up from the
    keyboard and monitor occasionally to open the window and look out to
    see whether a structural break might be in the works that is not
    foreshadowed in any of the sample data at the statistician’s
    disposal. (p 64-5)
  • The UK … a Net International Investment Position of around
    minus 27 percent of GDP in 2007 … a primary deficit of almost five
    percent of GDP. … both external assets and external liabilities are
    close to 500 percent of GDP. The characterisation of the UK as a hedge
    fund is only a mild exaggeration. (p 68)
  • The decision to discontinue publication of the M3 series also
    smacks of intellectual hubris; effectively, the Fed is saying: we
    don’t find these data useful. Therefore you shall not have them
    free of charge any longer. (p 80)
  • If we add together the statements by the world’s central bank
    heads (from the industrial countries, from the commodity-importing
    emerging markets and from the commodity exporting emerging markets) on
    the origins of their countries’ inflation during the past couple
    of years, we must conclude that interplanetary trade is now a fact:
    the world is importing inflation from somewhere else. (p 82)
  • On August 17, 2007, there were no US financial institutions for
    whom the difference between able to borrow at the discount rate at
    5.75 percent rather than at 6.25 percent represented the difference
    between survival and insolvency; neither would it make a material
    difference to banks considering retrenchment in their lending activity
    to the real economy or to other financial institutions. This reduction
    in the discount window penalty margin was of interest only to
    institutions already willing and able to borrow there (because they
    had the kind of collateral normally expected at the discount
    window). It was an infra-marginal subsidy to such banks – a
    straight transfer to their shareholders from the US tax payers. (p 97)
  • Both the 1998 LTCM and the January 21/22, 2008 episodes suggest
    that the Fed has been co-opted by Wall Street – that the Fed has
    effectively internalised the objectives, concerns, world view and
    fears of the financial community. This socialisation into a partial
    and often highly distorted perception of reality is unhealthy and
    dangerous. It can be called cognitive regulatory capture (or
    cognitive state capture), because it is not achieved by special
    interests buying, blackmailing or bribing their way towards control of
    the legislature, the executive, the legislature or some important
    regulator or agency, like the Fed, but instead through those in charge
    of the relevant state entity internalising, as if by osmosis, the
    objectives, interests and perception of reality of the vested interest
    they are meant to regulate and supervise in the public
    interest. (p 101-2)
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