The search for requisite variety goes on. At the moment, the big guessing game in British macroeconomics is “when does the Bank put up interest rates?” The following story suggests that this is beside the point.
The statement noted that mortgage demand was up 40% in the year to January, while surveys by the main mortgage lenders suggested prices were around 10% higher in February than a year earlier.
It said: “In a continuation of a longer-term trend, mortgages at loan-to-income ratios above four times accounted for a higher share of new mortgages in the third quarter of 2013 than at any time since the data series began in 2005. New mortgage lending at high loan-to-value ratios remained low by historical standards, though the number of mortgage products offering higher loan-to-value ratios had doubled over the previous six months.
“Given the increasing momentum, the FPC will remain vigilant to emerging vulnerabilities, will continue to monitor conditions closely and will take further proportionate and graduated action if warranted.”
Threadneedle Street intends to oblige banks and building societies to carry out stringent stress tests later this year to see whether they would find themselves in trouble in the event of a slump in house prices or a sharp rise in interest rates.
Yeah. Interestingly, most of the classic bubble pathologies are showing up – try this for size – but for the first time in my life, this seems to be accompanied by dread, not euphoria. Nobody is cheering.
These stress tests are interesting. First of all, the fact that the Bank needs to audit the banks to work out if it is actually possible to increase the policy rate without triggering a major bank failure is itself evidence that the situation I described in the original In Search of Requisite Variety post is coming to pass. The rest of the economy is more than lacklustre but the housing market is going ape again.
Secondly, the version of that story that appeared in the paper contained several paragraphs that don’t appear in the web version. For example:
Amid growing concern that the central London property market is already overheating, the Bank’s financial policy committee said that from June it wanted to have the powers to set the interest rate scenarios lenders would have to consider when granting home loans
Another quotes Brian Hilliard of Société Générale as saying:
Both of these metrics, loan-to-value and loan-to-income, appear in the list of potential future tools the committee could use. The FPC would probably move first on loan-to-income. The problem with controlling loan-to-value ratios is that it might be thought to run contrary to the idea of the government’s Help to Buy scheme
What’s going on here is that the Bank is seeking requisite variety. Specifically, they’re trying to create policy tools to address a housing bubble without imposing monetary contraction on the whole economy. Setting “the interest rate scenarios lenders must consider” and then auditing them should lead the lenders to turn down more applications for very large mortgages. Setting a limit in terms of loan-to-income would have a similar effect on mortgages applied for by borrowers who might struggle to repay them. Rather than changing the price of credit economy-wide, this would mean that some new applications would be credit-rationed.
This, of course, represents finance being re-regulated. In the de-regulation era, it was thought that the big issue was the overall price of credit, which a central bank could control. Its distribution among borrowers, sectors, and geography would find its own level. Brad DeLong’s Republic of the Central Bankers gets at this weird combination of enormous central-planning power vested in the Fed, and its restriction to hugely general and rough measures.
It was hoped that this represented a sensible compromise between the need for a stabilisation policy, and the avoidance of what was thought to be harmful bureaucracy. But another way of looking at the republic of the central bankers is that it is rather like Russia – it has a stash of nuclear weapons with which it can destroy the economy and that’s basically it. Precisely because its chief policy options are “Nobody notices” and “Blow everything up”, its day to day influence is often less than it imagines. It is also superbly, peerlessly unaccountable.
I am much in favour of re-creating a variety of policy responses. I am, though, worried that the regulatory power is being re-created in the unaccountable and often explicitly anti-democratic domain of the central bank. This is evidence, though, that the political system itself lacks requisite variety. Who do I vote for to re-regulate mortgage finance? As a result, the problem landed with the people who did have enough degrees of freedom to do something: the Bank.
Mark Carney agrees.
“This focus initially made sense since one of the greatest challenges for macroeconomic policy in the late 1970s and 1980s was the fight against inflation,” he said. “However, with time, a healthy focus became a dangerous distraction.”
He described the move by Brown in 1997 to give the Bank independence to set interest rates focusing on an inflation target as a “deconstruction of the old model of central banking”.
“In my view, while there were enormous innovations of enduring value during this period, the reductionist vision of a central bank’s role that was adopted around the world was fatally flawed,” Carney said in his Mais Lecture at the Cass Business School in London.