Thursday, July 8, 2010

Risk and the Limits of Monetary Policy

Two articles in the newspaper caught my attention this morning. And as they are related, they had more significant impact.

The first was from The Washington Post. Ezra Klein discusses some moves the Fed is said to be contemplating as there are signs the recovery may not be as strong as previously thought. The efforts are largely designed to provide banks with an incentive to lend.

This brings me to the second article, which was in The Wall Street Journal. (Subscriber content at this writing, but put “Risk Aversion Keeps Economy in the Slow Lane” in your browser and you may find a free version. This article talks about risk aversion both by borrowers and lenders. For borrowers, the desire to avoid debt when the future appears shaky is understandable. I suspect you tie in Keynes’ “paradox of thrift” when you discuss this. On the lenders side, it may be more complex. Yes, lenders are reluctant to lend, especially to businesses when the outlook is uncertain. But add the pressure being put on lenders by regulators and the government. The lenders are being chastised (in many cases correctly) for taking on excessive risk. This is being translated by many as “lenders shouldn’t take risk.” Unfortunately, credit involves risk.

We can get into the aspects of maturity risk, liquidity risk, and default risk another time. But when lenders are being chastised for lending, and borrowers are being told that things aren’t as rosy as we would have hoped, the appetite for risk is muted. I look forward to your thoughts.


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