re: investment and unemployment

[Warren Mosler <mosler@xxxxxxxx>]

In a message dated 07/04/2000 00:29:56 GMT Daylight Time,
mosler@xxxxxxxx
writes:

> And inflation raises the 'moral hazard' issue of geometrically
expanding
>  borrowing.
>
I do not see that. Inflation is the least painful way of reducing the
debt
overhang. Deflation makes it more serious and the geometrical progession
is
upped a power or two.

AGREED.  WHAT I WAS GETTING AT IS THE CASE WHERE INFLATION BECOMES
RELIED ON TO JUSTIFY LENDING STANDARDS.  FOR EXAMPLE, IF IT CAN BE
ASSUMED A MATTER OF PUBLIC POLICY THAT THAT HOUSING RESALE PRICES WILL
RISE, SAY, 10% A YEAR, LENDING AMOUNTS WELL OVER THE CURRENT MARKET
VALUE OF THE HOUSE MAY BE DEEMED 'SAFE AND RESPONSIBLE LENDING' PROVIDED
THE BORROWER CAN SERVICE THE DEBT LONG ENOUGH
FOR THE MARKET VALUE TO CATCH UP WITH THE BALANCE DUE ON THE
LOAN.  THIS CAN THEN LEAD TO ACCELERATING RESALE PRICES, ETC?


MANY
I seem to remember calculating that the real interest rate paid by
British
business in 1929 was around 29%.

However I do not want to give the impression I condone asset price
inflation
and would do nothing about it. This is in fact the prime target of "The
Gang
of Eight". We would use several means to reduce it, including varying
capital
adequacy ratios.

CLOSER EXAMINATION MAY PERHPAS REVEAL THAT SUCH RATIOS MAY NOT DUE THE
TRICK.
BANKS RAISE CAPITAL BY OFFERING INVESTORS A COMPETITIVE RETURN ON
EQUITY.  THEREFORE HIGHER CAPITAL RATIO REQUIREMENTS MEAN BANKS
HAVE HIGHER 'BREAK EVEN' SPREADS BETWEEN BORROWING AND LENDING
TO ACHIEVE THE 'SAME' RETURN ON EQUITY?
WE KNOW THE FUNDING RATE FOR BANKS IS BEST CONSIDERED FIXED BY
THE CENTRAL BANK, SO PERHAPS ALL THAT HIGHER CAPITAL RATIOS ACCOMPLISHES
IS A HIGHER COST OF BORROWING VIA A BANK LOAN?  AND
THIS, OF COURSE, MEANS THAT MORE BORROWERS WILL BE OF HIGH
ENOUGH QUALITY TO BORROW DIRECTLY IN THE CAPITAL MARKETS
AT LOWER THAN BANK INTEREST RATES?
AND HASN'T THAT BEEN OBSERVED IN ACTUAL PRACTICE, AS THE LAST ROUND OF
INCREASED CAPITAL REQUIREMENTS DROVE MORE BANK CUSTOMERS TO
DIRECT BORROWING?  NOT TO MENTION THAT THIS HAS ALSO NECESSARILY
MEANT THAT THE REMAINING BANK LOAN CUSTOMERS ARE OF LOWER
CREDIT QUALITY?  SO PERHAPS THE BOTTOM LINE IS THAT HIGHER CAPITAL
RATIO REQUIREMENTS LOWERS THE QUALITY OF BANK BORROWERS,
WITH MARKET FORCES TENDING TO ACT IN THE DIRECTION OF ADJUSTING
THE CREDIT QUALITY OF BANK ASSETS TO THE SIZE OF THE CAPITAL RATIOS
REQUIRED?

W

http://www.warrenmosler.com



Geoffrey Gardiner