As central bankers from around the world meet at their annual conference at Jackson Hole, a great deal of effort will go into defending their post crisis policies.
Even before the conference began, the ECB’s Draghi began the defense:
Policy actions undertaken in the last 10 years in monetary policy and in regulation and supervision have made the world more resilient. But we should continue preparing for new challenges…
A large body of empirical research has substantiated the success of these policies in supporting the economy and inflation, both in the euro area and in the United States…
Not surprisingly, he says the post crisis policies have been a success and he has research to support this conclusion.
But have these policies really been a success?
As regular readers know, I introduced the Information Matrix to show where financial crises occur in the financial system, how to end a financial crisis and how to prevent a financial crisis.
So let’s map what central bankers did to the Information Matrix and see if their policies could or should have had any impact. Below is the Matrix:
| Does Seller Know What They Are Selling?
|Does Buyer Know What They are Buying?||
Antique Dealer Problem
|No||Lemon Problem||Blind Betting|
Financial crises occur in the Blind Betting quadrant. The securities in this quadrant do not disclose the information necessary for investors to independently value them. Once doubt is cast upon their value, there is no logical stopping place for the decline in price of these securities other than zero. It is this price decline and related loss of confidence that is at the heart of a financial crisis.
With that background, let’s examine the central bank policies.
Did lowering interest rates to zero address the inability to value opaque securities driving the financial crisis?
Did purchasing government securities (those appear in the Perfect Information quadrant) address the address the inability to value opaque securities?
What these policies did do over the course of 10 years is make blindly betting on opaque securities Wall Street promised had a higher yield more attractive. But all that really does is set the stage for the next downward leg of the financial crisis when once again the value of the opaque securities comes to be doubted.
Having dispatched with the notion central bank policies were a big success. I will say central banks have managed to buy time to deal with the underlying problem of opacity in the global financial system.
However, buying time to address the underlying problem has never been a stated goal of the central banks. So it is hard to give them credit for something the central banks did not intend to do.