Again within the late Seventies, economists started exploring the “time inconsistency downside” in financial coverage. In the long term, we’re higher off if central bankers preserve a low inflation charge (or NGDP progress charge.) However within the quick run, the financial system could do higher with a extra expansionary coverage. The adverse penalties of that expansionary coverage might be largely borne by future policymakers.
It seems that the time inconsistency downside in central banking is considerably overrated. Central banks typically reach holding inflation low for lengthy intervals of time (however not just lately.)
Actually, the time inconsistency downside is way worse for banking regulation. Political and financial managers like President Biden, Janet Yellen, and Jay Powell would very strongly desire {that a} monetary disaster not happen on their watch.
There’s a typical however comprehensible false impression that there’s a type of tradeoff involving monetary stability and ethical hazard. Individuals assume that we will have monetary stability with ethical hazard, or we will have monetary instability with a regime free of ethical hazard. I can’t emphasize sufficient that this can be a false assumption!
Insurance policies that result in ethical hazard (authorities deposit insurance coverage, TBTF, bailouts, and so forth.), trigger extra monetary instability in the long term. There’s no trade-off to take advantage of right here. We don’t purchase a extra secure monetary system with bailouts. We encourage extra danger taking. So then why does the federal authorities preserve bailing out monetary actors that made dangerous choices?
Right here’s the place the time inconsistency downside comes into play. Whereas bailouts make for a extra unstable monetary system by encouraging ever-greater danger taking, within the quick run they do scale back monetary instability. And it appears as if President Biden, Janet Yellen, Jay Powell and the opposite key policymakers favor steps that may make for much less monetary instability over the subsequent 5 years, even when they might make for extra monetary instability over the subsequent 50 years.
PS. Whereas the media has targeted on SVB, the a lot greater outrage is the Fed’s new facility to bail out all banks that made dangerous choices. You acquire dangerous long-term bonds with short-term deposits? Don’t fear; the Fed’s acquired your again:
This is likely one of the darkest days in US monetary historical past—a panoramic growth of ethical hazard. Youthful readers ought to brace themselves for a lot worse within the many years forward. We’re sowing the seeds of future monetary crises.
PS. I extremely advocate studying Peter Conti-Brown’s tweets on this affair. Right here’s one instance:
