In this situation, policy normalisation needs to be clearly defined, and how it is carried out needs to be carefully judged and calibrated. In my remarks today, I will outline what it means to normalise monetary policy, what implications this normalisation has for our policy instruments, and how far it should go.
What This Means Is Banks Will Gradually Disappear Into The Background Of Our Financial Lives
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The higher real interest rates on government bonds have spurred an even larger rise in borrowing costs for consumers and businesses, and contributed to sharp declines in equity prices globally. The modal view of both central banks and markets seems to be that this tightening of financial conditions will be enough to push inflation down to target levels relatively quickly.
In the 1930s the less radical Glass-Steagall reforms won the day, and eventually the U.S. financial system stabilized. But a by-product of this victory was that critical pre-war lessons about the nature of banking had, by the 1960s, been largely forgotten. In fact, around that time banks began to completely disappear from most macroeconomic models of how the economy works.
4. What about the debt, which is the other great risk to an orderly and successful Chinese adjustment? There are two things China can do to address its substantial debt problem. First, it can simply transfer debt directly onto the government balance sheet so as to clean up banks, SOEs and local governments, thus preventing financial distress costs from causing Chinese growth to collapse. As long as this government debt is rolled over continuously at non-repressed interest rates, which will be low as nominal GDP growth drops, China can rebalance the economy without a collapse in growth. This, essentially, is what Japan did in the 1990s.
5. Although it may be hard to see it in the economic ratios, or in any real restraint in credit expansion, in fact Beijing has already taken serious steps towards rebalancing, although it may take a few more years to see this in the consumption share of GDP. The three most important of the transfers that created the imbalance have all reversed. The currency may still be undervalued, but not by nearly the extent it has been in the past, wages have risen quickly in recent years, and, most importantly by far, the financial repression tax has collapsed, and even nearly disappeared, which it will do fully in the next two years as nominal GDP growth continues to fall (as long as the PBoC does not reduce rates by much more than one or two percentage points over the next two years). Even the much-ballyhooed decision to improve the environment represents a partial reversal of one of the sources of the household share imbalance. 2ff7e9595c
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