Duncan’s Economic Blog

One for the critics (dropping the mask)

Posted in Uncategorized by duncanseconomicblog on March 17, 2009

So I rarely become annoyed. But I am annoyed . Annoyed by the following comment on Hopi’s blog:

‘You should read what Duncan has to say , in amongst the slavering New Labour lackey-isms he cannot help noticing some inconvenient facts like the fact our debt mountain has nothing to do with a stimulus bit is simply the result of the vast welfare state and its dependents moving out of a boom. Or the fact we cannot abolish the trade cycle . Pity Duncan was not saying such things when it was useful but then I daresay he was parroting the New Labour line that you could then.’

So, having watched the Watchmen movie (which is superb), it is time to drop the mask. My name is Duncan Weldon. I work here. I used to work here. And before that at the Bank of England.

Whilst in my old job, I wrote the following.

The future then, for banks, looks rosy. As long as they can fund increasing lending via capital
markets activity, profits will continue to soar. Funding via customer deposits seems so last century.
Moreover, it would be rather difficult anyway given Britain’s absurdly low savings rate of 5.2%.
The simple problem with this system, elegant though it appears (especially for the bankers), is that
it is built on foundations of sand. It is a model that relies upon risk premiums staying low: a change
in risk appetite or, more likely, a sudden realisation that investors are swallowing a lot more risk
than their appetite requires, could lead to the whole system falling down. If buyers of asset backed
securities start to demand a higher risk premium for owning these securities, then banks will witness
the cost of their funding soar; their ability to generate new loans will be severely restricted – it
could result in a run on the banks without a single deposit being drawn down.


another real worry is that so much of the banking sector’s funding is now short term (see next chart). It
is not too much of a stretch to envisage a situation whereby some unconnected event, perhaps in
land far, far away, causes investors quickly to reassess the risks they are bearing, driving up yields
across various types of debt instrument. When a bank tries to roll over its funding, as many must do
nearly every day, it suddenly finds that it needs to pay out a lot more cash than previously. We then
find ourselves in crisis mode, as a major bank desperately tries to find the cash to keep itself liquid
– with huge knock on effects through both debt and equity markets.

So please Newmania, less personal attacks.


Deflation (again).

Posted in Uncategorized by duncanseconomicblog on March 17, 2009

Fed Chairman Bernanke made a very good speech on deflation and the steps that could be taken to prevent it back in 2002. I highly recommend reading it. It very much represents the ‘playbook’ by which the Fed is handling the crisis.

For those without the time or inclination, I’ve summarised below.

So, over to Ben:

Deflation is defined as a general decline in prices, with emphasis on the word “general.” At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.

Followed by:

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.

Sounds rather like what we have now. The problem with deflation is that the traditional monetary policy response to a recession (cutting rates) may not work.

Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the “zero bound.”

So, as Bernanke goes on to explain unconventional policy responses are required. Starting with the central bank buying government debt (as has happened in the UK now) and moving towards the ‘ultimate weapon’.

the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

So, if it’s straight forward to beat deflation and generate inflation why did Japan fail to?

Japan’s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.

Sounding at all familiar?

Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan’s overall economic problems. As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.

The above paragraph is crucially important. We need strong actions now. I’d suggest two for starters. First a strong fiscal stimulus and secondly what Bernanke would term a ‘credible threat’ to cause inflation. So how about officially raising the Bank of England’s inflation target from its current level of 2% to 5%?

Nothing changes…

Posted in Uncategorized by duncanseconomicblog on March 17, 2009

I very much like this.

Written in 1897 about the depression of 1873 to 1875.

“Panics and Booms”

L.M. Holt

Ever since the establishment of the human race on this planet there has been a gradual increase of population and a more rapid consumption of wealth.

Wealth is the result of labor, and without labor there can be no wealth.

Men live and pass away, but as they cannot take their wealth with them a large percentage accumulates for the benefit of their successors. Hence the wealth of the world today, per capita, is much greater than ever before, and it is continually on the increase.

The transfer of wealth, or property, from one person to another creates business. Under favorable conditions, transfers are numerous and business is brisk. Under unfavorable conditions transfers are few and business is dull.

During periods of business activity there is work for all, and this of itself makes greater business activity. During periods of business depression there is not work for all, and this of itself makes business dull and unprofitable.

The existence of either one of these conditions leads necessarily to the other. It is an impossibility for either prosperous times or depressed times to continue permanently.

During prosperous times, there being work for all, all are supplied with the means of accumulating wealth, and thus all are enabled to provide themselves, and families with all the necessaries, and many of the luxuries, of life; and hence, during the prosperous times the demand for goods and property increases and soon the demand exceeds supply, and then prices advance.

This rule, which is applied to the laborer, is also applied to the business man. Prosperous times induce business men to branch out in their several lines of trade….The volume of trade being large, each gets a corresponding proportion of it. Many business men find that they can do more business than is allowed by their limited capital. They then buy on credit.

Prices are continually advancing, therefore they are able to make margins of profit not only on the capital furnished by themselves, but on the capital furnished through their credit.

This rule also applies to people dealing in real estate. The country is growing; money is easy; the times are good; business is prosperous and therefore speculation is favored. A man worth $5000 can buy four times that amount of property using his credit, and sometimes he buys ten times that amount or more. While prices are advancing he not only gets the benefits of the advance in the price of the property represented by the capital furnished by himself, but also on the capital furnished by his credit.

When prices of property and goods during a period of business depression are falling, the loss does not come on the entire property, but only on that portion of it represented by the cash capital the man has invested in it. The debt never shrinks until the real investment is all gone.

All people in a given section of country use their credit at the same time because they are all governed by the same local conditions. Hence, there is a fictitious stimulation of prices which must come to an end. This end brings a financial depression which must necessarily follow a period of business activity.

When the people arrive at a point where their credit limit is reached there is necessarily a decrease in the demand for goods and property, and soon the supply becomes greater than the demand and prices begin to decline. This stops speculation. Thousands of people engaged in manufacturing or producing articles of general use are thus thrown out of employment, and this causes a still further decrease in the demand for goods and hence a further decline in prices. Those who have purchased on credit find themselves subjected to heavy losses because they are compelled to sustain the depreciation on goods they do not own-that is, goods bought on credit. Because of this decrease in valuations all are compelled to economize in order to adjust their expenses to the new order of things, they being compelled to pay off the accumulated indebtedness with the decreased income. This economy of the masses still further decreases the demand for goods and property and this still further increases the supply over the demand, and decreases the prices, throwing more people out of employment and increasing the depressed condition of business. …