Macroprudential Tools: How They Help Prevent Financial Crises
Learning from and Teaching Ross Gittins
When Ross Gittins, a famed Australian economic journalist with a Bachelor of Commerce writes “…there being no free lunches”, he is mistaken.
These are words that I have written before.
It is with the understanding that the economic journalist is stuck within the thinking of the current economic orthodoxy and is slowly learning the heterodoxy of Modern Money and making the mistake, as many do, that MMT argues for monetising the deficit. That is using Australian Government Securities to presumably “fund” the deficit. However, the journalist recognises this is not true.
How do we know he recognises this is not true?
“Who said the shortfall between what a government spends and what it raises in taxes must be covered by borrowing from the public? That’s just a rule someone made up.”
Nonetheless, Gittins considers exchanging bonds for credits in exchange settlement accounts as money creation. Remember, this 75-year-old journalist is learning. We can forgive him for not understanding this is swapping one interest-bearing monetary instrument for a non-interest-bearing monetary instrument.
All monetary instruments make up money. Another term for a monetary instrument that can be used is a financial asset. There was just a swap of two existing financial assets. Remember monetary instruments such as cash would have bought the government securities in the first place and then later on they were swapped back. That’s it.
Gittins concludes with:
“It’s fine until there’s a financial crisis, which brings down banks and does huge damage to the rest of the economy, as we saw with the global financial crisis of 2008.”
Somehow, which is not explicitly made clear, this is connected to MMT. He recognises that competing banks make highly risky arbitrage arrangements that involve borrowing short-term and lending long-term. This is not inherent to MMT but rather in current banking and financial institution operating practices.
As for financial crises, they typically stem from inadequate regulation. In Australia, along with following the Basel rules, the international regulations for banks, the banks are also monitored by the Australian Prudential Regulations Authority (APRA).
APRA uses a range of macroprudential tools to prevent financial crises. These include setting capital requirements, liquidity requirements, and leverage limits. Capital requirements are the minimum amount of capital that banks must hold in order to operate. Liquidity requirements are the minimum amount of liquid assets that banks must hold in order to meet their obligations. Leverage limits are the maximum amount of debt that banks can take on relative to their equity. These tools are used to ensure that banks are able to meet their obligations and are not taking on too much risk.
In other words, APRA sets out the framework for when using macroprudential tools is appropriate. Is this enough? Not really, which is why when the 2008 Global Financial Crisis set in, the Australian government had to step in and guarantee $250 000 per person per bank along with guaranteeing the wholesale funding of Australia’s big four banks. It would be nice if the Commonwealth Government asserted some regulatory authority.
To make a profit, banks need creditworthy customers. They do not loan out of the exchange settlement reserve accounts. The central bank at the end of the accounting period, ensures there are enough reserves in the system through everyday open market operations. This involves buying and selling government securities in the open market in order to increase or decrease the number of reserves in the banking system. This helps to ensure that there is enough liquidity in the banking system to meet the needs of the economy.
If you enjoyed this free post, please consider buying me a cup of coffee!