Sunday, June 5, 2016

A simple explanation for the big monetary problem

“If we are tempted to assert that money is the drink which stimulates the system into activity, we must remind ourselves that there may be several slips between the cup and the drink.” His list of “slips” is well worth recalling:
“For whilst an increase in the quantity of money may be reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money; and whilst a decline in the rate of interest may be increase the volume of investment, this will not happen if [profit expectations] are falling faster than the rate of interest; and whilst an increase in the volume of investment may be increase employment, this may not happen if the propensity to consume is falling off.”

 The impact of monetary policy whether conventional or unconventional is uncertain because it depends on the action of a fickle public. The credit channel is complex with profit expectations and consumption being the hardest to measure. 

The current market state is that investors are not sure of the impact of any monetary action. The impact of the ECB buying corporates is not clear. We have an idea and an expectation, but success is driven by a willingness to make new investments. Any further action from the Bank of China is risky with respect to a credit bubble. The impact of the Fed acting  to raise rates is highly variable and thus requires the need for prudence. 

There is a greater need for policy coordination to increase the certainty of any action. The lack of coordination between monetary and fiscal policy is a driver for investor uncertainty.

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