Tuesday, June 29, 2010

Bank capital, lending and the recovery

I am starting to worry about monetary policy.

The word coming out of the G20 summit and from the Bank of England is that banks are going to need to build up a lot more capital in their reserves so that they’ll be better able to weather another financial storm. This is sensible. But it means that they’ll be less willing and able to lend at decent rates – in effect, tightening monetary policy without the Bank of England raising its base rate at all – which will reduce consumer spending and business investment.

Sure, nobody is proposing that new capital requirements be rushed in, but given that we’ve got some hefty fiscal tightening every year as far as the eye can see, when is going to be a good time to squeeze the monetary side too?

According to the Institute of International Finance, the new rules would cut GDP across the USA, Europe and Japan by 3.1% by 2015. Admittedly, that number looks like it’s been pulled out of a complex series of hats, but the risk is there.

And what’s more, the Bank for International Settlements reckons that central banks should be raising their base rates sooner rather than later; the unprecedented near-zero levels were appropriate for the recession, but now there’s a risk of another asset-price bubble and “discouraging needed reductions in leverage, thereby adding to the distortions in the financial system and creating problems elsewhere”. We already have one MPC member who wants higher rates.

I hope this turns out to be unduly gloomy, because with the pound rising against a troubled eurozone, an export-led recovery’s less likely as well.

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