Sunday, October 27, 2013

At least he highlights the right part

In a recent post Nick Rowe quotes from the latest Bank of Canada report:
"Although the Bank considers the risks around its projected inflation path to be balanced, the fact that inflation has been persistently below target means that downside risks to inflation assume increasing importance. However, the Bank must also take into consideration the risk of exacerbating already-elevated household imbalances." (my bold)

(His bold.) Nick goes on to explain the bolded part:

Translation: "We would maybe like to cut interest rates to prevent inflation staying below target, but we are scared of doing this because it might cause some people to borrow too much..."

When the Bank of Canada refers to "already-elevated household imbalances" it means people have already borrowed too much and lowering interest rates more (according to Nick's translation) might cause people to borrow even more.

What problem does the Bank of Canada identify? Already-elevated household debt.

What problem does Nick Rowe overlook? Already-elevated household debt.

Nick's recommendation? "The best cure for 'easy money' is easier monetary policy". But Nick is not dealing with the problem. The problem is already-elevated household debt. Nick doesn't dispute it. He just argues around it, saying the Bank should lower interest rates and make money easier.

See how he takes the Bank's "elevated household imbalances" and reduces it to a problem of "some people"? If it was only "some" people who had borrowed too much, there wouldn't be a macroeconomic problem. Take out the word "some" and put in the word "most". While we're at it, take out "it might cause" some people to borrow too much, and use something less iffy: It has caused most people to borrow too much.

But it's probably not low interest rates that caused it. If Canada is anything like the US, it's all the encouragements to borrow built into the tax code and other policies. Things that don't even originate with the central bank.

Nick thinks he can solve this problem by making easy money even easier.


Nick Rowe said...

Arthur: there's (at least) one big difference between Canada and US tax codes. We don't have mortgage interest deductability. So Canadians have a bigger incentive to pay down and pay off their mortgages.

A second big difference is that Canadians (mostly) can't do "jingle mail" and just handover their house to the bank and walk away from the mortgage.

Yes, there may be a problem with some people borrowing too much. But tighter monetary policy will make that problem worse.

The Arthurian said...

Hi Nick. I agree absolutely: tighter monetary policy will make that problem worse.

Door #1 is easier money. Door #2 is tighter money. I am trying to open Door #3: Money is tight relative to private debt. Make money easier by reducing private debt.