Thursday, December 25, 2008

Bank of England Deputy Governor admits to Bank's lack of understanding



John Gieve admits that the Bank of England did not understand the severity of the financial crisis. Such honesty is to be admired.

The Bank has been trying to chase one variable (inflation) using one tool (interest rates). This is not enough to keep tabs on a modern financial system. Prior to the 1980s, other forms of credit control existed. They were a more direct way of influencing the economy than interest rates are. If the bank had more quantitative controls like that, then it would have been able to nip the crisis in the bud in a way it can not do with its current measely set of tools. To control asset price inflation by merely raising interest rates would have crippled the productive economy. Only by fixing quantitative restrictions on the volume of mortgage lending could the bank have stopped an asset price bubble while protecting productive parts of the economy that need cashflow and credit to function.

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