Policy driven by erroneous ideas
The most common response I have had to the proposals made in my book for a new banking system and global monetary reform is that they are too radical, too ambitious, and won’t happen. When I ask such critics (who are usually of a friendly disposition) what are they suggesting, they usually reply that slow but steady progress is best made by incremental steps, each one improving matters in a specific field. Reject the big ideas, do what you can. Look at the ground at your feet, not at the heavens above.
Progress is being made, they say, in reforming the banking system, raising capital requirements, Basel III, etc. There is no substitute for the hard slog of hammering out international standards and agreements – Mark Carney gives a very pretty speech on this. Christine Lagarde can give an even prettier speech on steps to reform the international monetary system. The IMF has a website on this topic, even though what they call “reform” bears scant resemblance to what is traditionally meant by that term.
How does one answer this kind of criticism?
Of course in one sense such critics are right by definition. What happens is what happens and there are reasons for what happens just as there are reasons why what doesn’t happen doesn’t happen. But unless one believes in a very hard form of historical inevitability – which nobody can who drives to work in the morning – then ideas can make a difference. What happens depends not just on fact but on the ideas that people take around with them in what Agatha Christie’s detective Hercule Poirot called their “little grey cells”.
The stuff that policy makers carried around in their grey matter pre-crisis shaped what they did. Listen to Charles Goodhart at the recent INET conference. It’s amazing stuff. The models that central bankers and economists who advised them excluded by assumption everything that should concern central banks; e.g. was no risk; no money; default was excluded.
Since the outbreak of the crisis, similarly, policy making has been driven by erroneous ideas. Moderating the process of bank de-leveraging and lowering risk premia, which are what really matter, has been neglected in favour of forward guidance on short-term interest rates. Efforts to stimulate bank lending by raising capital ratios has had the opposite effect to that intended – causing banks to reduce assets – because the effect of the policy on incentives was ignored.
It is not that nobody wants to borrow from the banks but that bank CEOs are trying to achieve higher capital ratios mandated by supervisors by selling assets to avoid diluting capital and thus reducing the rates of return that determine their pay levels.The policy since the crisis has made matters worse.
What was in their little grey cells hid from policy makers everything that really matters about the financial system; they were smoking the fag ends of a theory.
Older readers will recall that Charles also persistently warned that Basel II would be pro-cyclical – and so it proved.
Yet Charles is a mainstream economist par excellence. If INET had the courage of its convictions and had invited an Austrian economist – or anybody of a more radical disposition – the audience would have been treated to an even more explosive critique.
In so far as policy caused the crisis (and even some central bankers like Mervyn King are moving their ground on this) it was because it was driven by wrong ideas. Likewise with the persistent recession (the IMF is again downgrading prospects for the third year in a row). Wrong ideas equal bad policies.
So when people say “Calm down, Robert; we are getting there”, it makes me see red. These silly little small steps are actually taking us away from a solution, not towards one.
As Mervyn King, again, has pointed out, not one of the underlying causes of the crisis has been solved. William White and others keep trying to point this out. So do more radical economists, especially the free market school such as Kevin Dowd, Brendan Brown, George Selgin, people from think tanks such as the iEA and the Adam Smith Institute, the von Mises Institute, and the leader writers of the Wall Street Journal. So do figures from the left such as David Graeber.
But policy is in the grip of The Money Trap – and of conventional types who can’t see any alternative.
Please read the book with an open mind!