Sunday, October 18, 2009
Honey, I'd shrink the banks
Posted by David Smith at 02:00 PM
Category: David Smith's other articles

posen.jpg

An interview with Adam Posen of the Bank of England's monetary policy committee

After spells at the Federal Reserve Bank of New York and as No 2 at Washington’s leading economics think tank, Adam Posen might by now be setting monetary policy in America.

Instead he answered an advertisement to serve as an external member of Bank of England’s monetary policy committee (MPC).

Posen — the second American to serve on the committee after DeAnne Julius — did not, he said, join as a “newbie” on the British economy.

He has followed the economy for a long time and has previously spent seven months at the Bank on a fellowship.

Posen, 42, engaging and inquisitive, has spent the time since his appointment to the post, which carries a salary of just under £100,000, reading up on the economy and meeting economists. He has a clear diagnosis of why we got into trouble.

“The UK suffered from two blows,” he said. “There was the almost inevitable fact that we were going to have a recession and that some correction in asset prices was going to happen and was going to slow the economy, and not to a trivial degree. Then we had the financial panic of a year ago and the risk of the end of financial life as we knew it, and that made things much, much worse.

“Where we are now, I think, is that the Bank and the government — and other leading governments and central banks — have pulled us back from the brink and ruled out the worst possible outcomes. Now we are back to coping with a normal recession. It’s pretty severe but we are five quarters in and it looks like we are bottoming out.”

So is it a question of waiting until the recovery comes through in the normal way? What Posen describes as a “race against time” is under way to discover whether the banking system will be strong enough to support a sustained recovery.

“We are going to have a stable financial system but the structural problems of that banking system haven’t been resolved. That shouldn’t be shocking news to anybody.

“Two of your big banks are in government hands and by universal acknowledgement there are a lot of bad assets on the books. The biggest risk to a sustainable private-sector recovery is that the banking system problems are not fully resolved by the time we have to pull back.”

For him this is the critical question. Though it is now more than a year since the worst of the crisis, it is still not clear that the banks will be able to support the upturn.

“Time heals all wounds but you would prefer the banks to be engaging in some sort of physical therapy and getting on their feet rather than lying there and waiting for it to happen,” he said. “You don’t want other parts of the economy getting ready to recover but being constrained by misallocation or too limited credit.”

His criticism of the banks does not stop there. Even a brief immersion in Britain’s banking system has convinced him the structure is wrong. The problem of “too big to fail” is not just about big global banks — it starts right here in Britain.

“There were some fundamental problems in the system that were exposed by the crisis, including the behaviour of ‘too big to fail’ institutions and the severe concentration of the banking sector in the UK, and I think those two things compound each other,” he said. “There may be a case for limiting bank size, full stop.”

What might that mean in practical terms? If he had his way, it would mean the break-up of some of Britain’s banks.

“We have to think about restructuring the banking system, especially where the government already has huge stakes, and that’s not just in the UK, but obviously starting in the UK,” he said. “That’s where the debate has to move.”

Both Royal Bank of Scotland and Lloyds Banking Group are big, and the government has large stakes in both. “There’s no reason we shouldn’t be able to say, if we decide: ‘Sorry, super big banks don’t make any sense — the costs are too great’,” he said. “You don’t necessarily return the banks in government hands to the private sector in the form and size that you started with.”

One of Posen’s main research interests is Japan, and how it got bogged down in stagnation and deflation.

Japan pioneered quantitative easing, so he knows a lot about its experiment. Though the Bank started quantitative easing in March, while Posen was watching the British economy from the other side of the Atlantic, he is an enthusiastic supporter. “It’s perfectly sensible and it seems to be working,” he said. “It’s what you do. You know that the sign on the economy, meaning the direction, is going to be towards more growth, towards reflation, towards other assets, and you know you have to do a lot because there are a lot of assets out there. It was always an illusion to believe you could do it with pinpoint accuracy.”

He draws the analogy of driving a new car along the motorway and doing the same journey on back roads in a 10-year-old Vauxhall Astra: “I know I’m going to get there but it might take a little longer.”

As for inflation, he draws on his experience of Japan. “Because we are making purchases now doesn’t mean that it has a huge effect on prices in the future,” he said. “There are simple ways of looking for that in the data and it’s not there but the best example is Japan. Japan did huge amounts of quantitative easing and they are still fighting deflation.”

Though some of his language is dovish, Posen insists he approaches the question of meeting the inflation target in an even-handed or symmetrical way, giving equal weight to deflation and inflation.

The big debate within the Bank will be whether to extend quantitative easing beyond the £175 billion mark. Sterling received a boost last week after one MPC member, Paul Fisher, hinted that there may be a pause in the process next month. Posen is not so sure, suggesting that if it were left to him, he might go further.

What about when the Bank stops quantitative easing? What will be the exit strategy?

“This is why we are paid the medium-sized bucks because it’s not an easy choice,” he said. “This is not November 2008 or February 2009 ... there will come a point when it’s not needed. One thing the world doesn’t need now is disorderly markets. From a monetary-policy point of view we want to make this a smooth transition.”

From the Sunday Times, October 18 2009

Comments

RBS would be prime for having some of its 20 or so subsidiaries jettisoned (would they count as privatisations?). Surely though regulating the size of banks would depend on the incoming Conservative government's willingness to act. I'm not really a politico but i would guess that that willingness would have something to do with who funds the party's election campaign, 2010 won't be 1997 - they still need to put in some effort.

Also, on your previous article on jobs i would happily lay the odds that we get over 3 million unemployed before March 2010. Temporarily ignoring the increased labour market flexibility, From the previous three daddy-recessions unemployment continued to rise well after the first quarterly increase in output, i'm thinking of LFS working age unemployed Oct 1977: 1.48 mln (5.8%); Apr 1984: 3.22 mln (12.1%); Jan 1993 3.0 (10.9%), on the same measure Jun 2009 2.43 mln (8.1%). I just don't think job creation and demand is there to halt the march beyond 3 million.

Finally, also in relation to your last article, can you explain why Yvette Cooper makes me really really angry whenever she tries to talk economics.

"The first was from the Department for Work and Pensions. Yvette Cooper, its secretary of state, ordered an investigation into why the two main unemployment measures, the claimant count and the Labour Force Survey measure, were diverging."

Hurrah! for the return of the comments board.

Posted by: Johnny Blaze at October 18, 2009 09:19 PM