Thursday, May 21, 2009

Automatic stabilisers in interest rates

In the first of my posts on The Tanner Thesis I noted the way a more sophisticated set of tools could be used in prudential regulation to manage asset price bubbles. Crikey today reported a speech by RBA Assistant Governor Guy Debelle in which he talked about why central banks can't just raise interest rates to control asset price bubbles, as the consequence is flattening of the economy.

This point was well made by J.K.Galbraith in his The Great Crash that was his analysis of the crash of 1929. His analysis was that the central banks couldn't have stiffled the asset price boom in shares without killing the economy - though I guess the economy tanked anyway.

Anyhow Debelle said "But other tools, most notably the much-touted (although not clearly defined) macro-prudential instruments, should be used to address asset price and credit imbalances. I do not think that a slightly tighter setting of interest rates would have prevented the development of the imbalances that have led to the current financial crisis."

So I went to figure out what these tools are and they do look like what I have been talking about for use - changes in the capital adequacy rules under positions of asset price inflation. This is explained in more detail in the Turner Review in the UK.

One other point that they suggest is a similar regime for "mark-to-market". This is the policy that assets get revalued to market - but this could be amernded to say the upward revaluation is limited by some overall "speed limit".

The bad news, however, is that once we work out this lot of stabilisers the next economic crisis will come from another area where we haven't yet identified the need for a stabiliser.

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