Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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# Credit expansion and credit misallocation

Authors:   
Discussant: None  
Video: https://www.youtube.com/watch?v=TYBhOiyjsFg&t=0s


## Talk (00:00:00 – 00:32:52)

[00:00:04] One of the things when you pay much attention to financial instability around the world is how frequently it's correlated with problems in the real estate sector.  
[00:00:14] And that's kind of long puzzled me.  
[00:00:17] And there's also the comment that the US problems in real estate originated from loose monetary policy in the early 2000s.  
[00:00:27] And that also kind of puzzled me because by the end of the boom, monetary policy had been pretty much normalized.  
[00:00:35] And so I found this paper by Alexander Black that's going to talk some about how financing can influence real estate prices.  
[00:00:45] He is on the faculty at the University of British Columbia.  
[00:00:49] It was published by Giulio Coronado, who is president and founder of macro policy perspectives.  
[00:00:56] And there is additional information on both speakers in your packet.  
[00:01:01] And with that, I'll turn it over to Alexander.  
[00:01:03] Well, thank you so much for putting the paper on the program to Larry.  
[00:01:09] He's seen the paper once before, and so I'm kind of grateful that you're willing to sit through this one more time.  
[00:01:16] And I have to say, it's a little bit intimidating to speak to such a diverse audience, some of which are policymakers.  
[00:01:22] And the paper sort of has a bit of the flavor of highlighting an unintended consequence of policy.  
[00:01:30] So I guess I'm on very thin ground here.  
[00:01:33] And as our speaker, Tamara, pointed out, it's hardly as bad as following lunch.  
[00:01:39] It's not quite as bad as following Larry's summer.  
[00:01:42] I think I have the easier task today.  
[00:01:45] I should stop complaining.  
[00:01:47] So this is joint work with somebody who used to be my PhD classmate a while ago,  
[00:01:52] Xuan Liu, who is in Hong Kong at HKUST.  
[00:01:56] And in the paper, basically, we try to think about why monetary policy,  
[00:02:04] especially the very aggressive kind that we have observed following the financial crisis,  
[00:02:10] apparently wasn't all that effective all the time everywhere, and what might explain that.  
[00:02:17] And part of the answer is that there are some unintended consequences, naturally.  
[00:02:23] And I try to maybe see if I could open your mind to that a little bit.  
[00:02:28] Okay, so I have to say the talk is quite high level, so I hope I got that pitch right.  
[00:02:37] But let me try to motivate that first with some observations.  
[00:02:41] I probably, in this room, I don't have to motivate that very much,  
[00:02:44] that following the financial crisis, there was enormous stimulus,  
[00:02:48] especially of the monetary kinds in various forms and shades around the world.  
[00:02:55] And it's fairly obvious that the stimulus was motivated by the fact  
[00:03:01] that we were trying to save all these economies from dipping into a recession  
[00:03:06] following the financial crisis.  
[00:03:08] But what's turned out is that apparently these policies were not always that effective,  
[00:03:15] and I'm going to free write on Ragu's argument on what effective is here,  
[00:03:19] on stimulating the real economy.  
[00:03:23] Apparently some places in the economy were very much stimulated,  
[00:03:27] but apparently not always the ones that we thought ought to have been stimulated.  
[00:03:32] And that is, I think, if you look around in the data,  
[00:03:35] that's particularly true, I think, in emerging markets.  
[00:03:39] And a very illustrative case in point of that is actually China.  
[00:03:43] And China for, I think, two reasons.  
[00:03:45] One, the stimulus package was extremely large there.  
[00:03:49] It was about, depending on a little bit how you count it,  
[00:03:52] about twice that of the United States by some measures, 13% of GDP at the time,  
[00:03:58] not all of which was monetary stimulus,  
[00:04:01] that's included I think is about around a third.  
[00:04:04] But also that's not the only reason.  
[00:04:06] The second reason is because in China, China is a very much heavily bank-based system.  
[00:04:12] And so both of these things, when you think about how the stimulus  
[00:04:16] should have transmitted through the banking system  
[00:04:18] and the money should have ended up at the right places,  
[00:04:20] is of course the place to look when you want to think about  
[00:04:22] why the money didn't end up in the right places.  
[00:04:25] And so when you look at the data, the stimulus was extremely large.  
[00:04:31] You can see the, it's not a very sophisticated graph here,  
[00:04:34] but if you look at that graph, it probably sticks out to you  
[00:04:37] that the money supply jumped up substantially.  
[00:04:41] And in response, funding to various places in the economy increased.  
[00:04:47] In particular, bank lending just about doubled.  
[00:04:51] And so you can see this also when you look at the composition of funding  
[00:04:55] in the economy.  
[00:04:57] And I want you to focus I guess on the big blue chart, which is bank lending.  
[00:05:02] And so you could see that the biggest increase was in the form of bank loans  
[00:05:08] that about doubled in one year.  
[00:05:12] So that's a massive, I would call that a massive stimulus.  
[00:05:16] And so the question is, well, what happened to that money?  
[00:05:19] And let's maybe check some outcomes.  
[00:05:21] And we're not trying to be too provocative here,  
[00:05:23] given the introduction that Larry just gave.  
[00:05:26] Apparently, one thing you can see is that some markets,  
[00:05:29] especially housing markets, apparently responded quite strongly.  
[00:05:34] So this is, of course, cherry pecked a little bit, Beijing,  
[00:05:39] where house prices, much like in where I currently live,  
[00:05:42] Vancouver, about doubled in about two years.  
[00:05:47] You can also pick Shanghai, and it looks not too different.  
[00:05:53] But that's not the only markets that apparently had a boom.  
[00:05:56] I could also go on down the list.  
[00:05:58] Commodity markets seem to have experienced a similar thing,  
[00:06:03] that when you strip out things like agriculture, so food and fuel,  
[00:06:11] so things that were probably commodities that were used more for production,  
[00:06:15] they also just about doubled, a lot of which in price,  
[00:06:19] a lot of which was attributed to China.  
[00:06:24] I ran out of graphs here, but if you looked at the stock market in China,  
[00:06:29] that pretty much followed a very similar pattern.  
[00:06:33] And yet, if you look at the real sector,  
[00:06:38] so I kind of abused this here at the top here,  
[00:06:40] I call this the financial sector,  
[00:06:42] it's what I call, I guess, the non-real economy sectors,  
[00:06:45] real estate commodities, the stock market.  
[00:06:48] If you look at the real sector that apparently we were trying to stimulate  
[00:06:51] with these massive packages, there's a different picture that emerges.  
[00:06:57] In particular, if you look at small to medium enterprises  
[00:07:01] that still make up the chunk of the economy even in China,  
[00:07:05] in fact, things looked actually worse than they looked before the stimulus.  
[00:07:10] That is, there were lots of places where actually their borrowing rates  
[00:07:14] increased after the stimulus, not decreased,  
[00:07:17] which is what you would expect from traditional explanations of monetary policy.  
[00:07:24] And to some extent that became so problematic  
[00:07:27] that some of these firms actually were totally left out of the credit market altogether  
[00:07:31] after the stimulus.  
[00:07:33] So apparently, I'm trying to suggest here that yes,  
[00:07:38] some sectors were very much stimulated,  
[00:07:40] but the places that we might have thought should have been stimulated  
[00:07:43] apparently weren't or even had a harder time getting financing than before the stimulus.  
[00:07:50] But even though China, for those reasons that I mentioned,  
[00:07:54] the fact that they're bank-based and had a large stimulus package,  
[00:07:58] even though that's, I feel, a good illustrative case in point,  
[00:08:01] there are similar phenomena, if you look in other economies.  
[00:08:05] Now the alphabet soup kind of takes off here,  
[00:08:09] so in the U.S. we call it credit-easing  
[00:08:11] and there were a number of rounds.  
[00:08:14] So the fact that we had QE1234, or as Ragu said, to infinity,  
[00:08:18] probably suggests that any one of these rounds could not have done the job.  
[00:08:22] It was also massive and you looked in other places, Europe, Japan,  
[00:08:27] or other emerging economies, the picture is somewhat similar.  
[00:08:31] And there is, just since we are in the U.S.,  
[00:08:33] there is now some evidence of that type of stimulus in the U.S.  
[00:08:38] And they highlight also that following the stimulus,  
[00:08:44] apparently credit to the real economy, in fact, was also reduced by banks,  
[00:08:51] and that the stimulus package actually had very different effects  
[00:08:58] on credits to different places.  
[00:09:01] So mortgage credit apparently went up,  
[00:09:04] but commercial credit didn't.  
[00:09:08] And so these are sort of similar phenomena there.  
[00:09:13] And so the question is, you know, what explains this?  
[00:09:17] And one way to think about this is, you know,  
[00:09:20] what, for example, do these three examples here of sectors, the top,  
[00:09:26] what do they have in common, why are they so fundamentally different  
[00:09:30] from what we would call some chunks of the real economy?  
[00:09:35] And so naturally we're wondering, you know,  
[00:09:37] what is therefore the best response by policy?  
[00:09:40] What is the optimal policy here?  
[00:09:43] And apparently since we're trying to explain the somewhat unexpected picture,  
[00:09:47] what is the limitation of it?  
[00:09:49] What is the downside of having such expansive policy?  
[00:09:53] And so specifically, I guess we want to ask two questions  
[00:09:56] that have made it somewhat shorter here.  
[00:09:58] One is, what is the effect on lending?  
[00:10:02] You know, how well does this strong policy  
[00:10:05] transmit through the banking system?  
[00:10:08] And what does it do to asset prices in these different sectors?  
[00:10:13] And so the answers that we want to give are  
[00:10:16] that there is crowding out of credit to some places  
[00:10:22] if monetary policy becomes too expansive  
[00:10:25] and that certain asset markets you should expect to boom.  
[00:10:30] Now probably when you look at this,  
[00:10:32] the first argument I think is new.  
[00:10:34] The second argument I'm sure you've heard before.  
[00:10:37] Now our argument is a little more intricate.  
[00:10:39] We would say that in fact those two are not unrelated phenomena.  
[00:10:42] In fact, there's sort of two sides of the same coin  
[00:10:45] that it is because they're asset booms in some places  
[00:10:49] that causes credit not to go to certain places.  
[00:10:55] And so the punchline then would be that  
[00:10:57] monetary policy itself in trying to address one market failure  
[00:11:02] that in the credit market actually causes a market failure  
[00:11:07] that is I guess the unintended consequence, the downside of it  
[00:11:10] when it becomes excessive.  
[00:11:12] Okay?  
[00:11:14] Okay, so let me back up and become a little more high level  
[00:11:19] which I guess is an academic you always attempted to do.  
[00:11:23] And so when I first thought of this,  
[00:11:25] you might have noticed in the program  
[00:11:27] my job is actually that of a bean counter, a professor of accounting.  
[00:11:31] But my research interests I guess as you can see are fairly eclectic.  
[00:11:36] When I first looked at this with my co-author,  
[00:11:39] I tried to figure out what is, since this is somewhat new to me,  
[00:11:44] what is so special about this?  
[00:11:46] And so one thing I noticed  
[00:11:48] is when you look at how monetary policy is implemented,  
[00:11:52] it in fact is implemented in a particular way.  
[00:11:55] The central bank through its various tools and mechanism  
[00:11:58] doesn't give money directly to the real economy,  
[00:12:00] which you know if you looked at this picture and you said  
[00:12:03] well the money doesn't end up there,  
[00:12:05] well why don't they just give the money to the real economy?  
[00:12:07] We don't I guess typically pick winners and losers  
[00:12:10] as the central bank so there's no direct lending  
[00:12:12] to the real economy but instead we give it to the credit market  
[00:12:16] in the hope that the credit market will put it in the right hands  
[00:12:19] in the real economy.  
[00:12:21] And you could see probably why that would make a good sense.  
[00:12:25] The banks of course by their existence  
[00:12:28] are the ones that probably have better information  
[00:12:31] about where that money is most effectively invested,  
[00:12:34] who the deserving borrowers are.  
[00:12:36] And so since it didn't work there must be some downside  
[00:12:40] and our explanation is that there is an imperfect alignment  
[00:12:44] between how the central bank,  
[00:12:47] if it had the information about the deserving borrowers,  
[00:12:50] would lend and what the individual private commercial bank would do.  
[00:12:55] Broadly speaking I guess the central bank has  
[00:12:59] a much broader thing in mind, the economy as a whole,  
[00:13:02] it has the social value in mind,  
[00:13:05] the individual commercial bank is much more narrowly interested,  
[00:13:08] self-interest in its profit,  
[00:13:10] its risk-adjusted profit from a lending transaction  
[00:13:13] and therefore you don't expect those two to do the same thing  
[00:13:17] even if they share the same information.  
[00:13:19] And so that I guess that downside,  
[00:13:24] that misalignment leads us to think  
[00:13:27] that when you take money as a central bank  
[00:13:30] and you give it to these commercial banks  
[00:13:32] that don't necessarily have the same incentives,  
[00:13:35] relying and implementing the policy through the credit market  
[00:13:39] could actually distort this credit market  
[00:13:43] and as a result therefore actually produce another market failure  
[00:13:47] in the attempt to correct another,  
[00:13:49] which has of course helped the credit market  
[00:13:51] on its feet in the first place.  
[00:13:53] And so another way to put this is that  
[00:13:56] which seems somewhat curious to me  
[00:13:59] who admittedly had not thought about this very much  
[00:14:01] before this came along,  
[00:14:04] is that typically policy is motivated on some market failure  
[00:14:08] and clearly in this case you would think it's a failure  
[00:14:11] in the credit market to efficiently allocate credit in the economy  
[00:14:15] but now that we observe that there is this failure  
[00:14:18] what we do in response with the policy  
[00:14:20] we give more money to the failed market  
[00:14:22] to do the allocation that it wasn't happy to do effectively beforehand  
[00:14:26] and so that to me seemed like a little bit logically  
[00:14:29] not fully consistent.  
[00:14:31] And so that to an economist of course  
[00:14:33] that sounds like what they would call  
[00:14:36] the theory of the second best.  
[00:14:38] If you've got one problem in the economy  
[00:14:40] and you try to address it with policy  
[00:14:42] you better make sure that that policy  
[00:14:44] does not worsen another problem in the economy  
[00:14:47] to the overall detriment in the economy  
[00:14:50] and I guess that is what we're trying to potentially use here  
[00:14:54] to explain why this excessive policy might have backfired.  
[00:15:00] Okay, so the basic idea is that if you think back to  
[00:15:03] I guess the basics of monetary policy or microeconomics  
[00:15:10] by the way what I'm going to say now is  
[00:15:12] I'm going to be a little bit loose with some terminology  
[00:15:15] and use words like liquidity, money and credit  
[00:15:18] as if they were the same thing.  
[00:15:20] I hope you, I don't have to explain to you  
[00:15:23] that they're not the same thing but just for the sake of the talk  
[00:15:27] I'll pretend as though they are  
[00:15:29] so as a non-native speaker it makes it a little bit easier for me.  
[00:15:34] So what you would expect is as the monetary policy expands  
[00:15:39] as the supply of money goes up  
[00:15:42] the price of money, money is not as scarce anymore  
[00:15:46] the price of money should go down  
[00:15:48] the interest rate should fall  
[00:15:50] and therefore all else equal firms would have an added incentive  
[00:15:55] to perceive value attractive investments  
[00:16:01] and that's against the traditional channel.  
[00:16:03] Now we want to argue that you should not expect to be true  
[00:16:08] in a context where you take the problem  
[00:16:12] that motivates monetary policy in the first place seriously  
[00:16:16] in academic speak in a general equilibrium  
[00:16:19] the demand for credit, the demand for liquidity  
[00:16:22] and the supply of liquidity are not independent  
[00:16:25] in fact we would argue that the supply of liquidity  
[00:16:28] affects and causes the liquidity demand to change  
[00:16:33] and therefore since both of course  
[00:16:35] determine the price of money, the interest rate  
[00:16:37] you know have to be careful on just exactly  
[00:16:41] how this multiplier if you will  
[00:16:43] the extra effect on liquidity demand works  
[00:16:46] to make sure that the policy indeed has the desired effect  
[00:16:49] now most of the time I'll say  
[00:16:51] this actually goes in the right direction  
[00:16:54] so the argument is as follows  
[00:16:58] what happens here, the reason the liquidity  
[00:17:03] can affect the liquidity demand  
[00:17:05] is because of the reason why firms find it difficult  
[00:17:09] to borrow in the first place, the financing friction  
[00:17:12] and so the optimal way to finance  
[00:17:15] often is therefore to resort to secured lending  
[00:17:20] in which the very investments project becomes  
[00:17:24] or has a dual role, it's no longer just a source of production  
[00:17:27] but also the thing that makes the borrowing easier  
[00:17:31] it serves as collateral  
[00:17:33] and therefore a bank that sits there and says to itself  
[00:17:37] well if I were to lend to this firm  
[00:17:40] and this deal is gonna go belly up  
[00:17:43] well how could I secure, how could I reduce  
[00:17:46] my risk in a transaction, well if there is  
[00:17:49] fundamental or strategic default  
[00:17:51] the guy can't pay back, I'm just gonna seize  
[00:17:53] the collateral and sell it  
[00:17:55] and therefore what mitigates the risk to the bank  
[00:17:57] is of course a higher future market price  
[00:18:00] of this investment  
[00:18:02] so the higher the rationally anticipated market price  
[00:18:05] the more the bank is willing to lend  
[00:18:09] against this higher value of the collateral today  
[00:18:12] and therefore as if it is true that  
[00:18:16] more money spent essentially in a sector  
[00:18:19] does have the effect as I'll try to convince you in a bit  
[00:18:23] appreciate potentially the asset price  
[00:18:26] that now means that everyone in the sector  
[00:18:28] could borrow more  
[00:18:30] the collateral value is higher  
[00:18:32] and therefore that you would think is a good thing  
[00:18:36] for everyone in this sector  
[00:18:38] so therefore the fact that this supply does effect the demand  
[00:18:41] is actually a good thing  
[00:18:43] even though it does muck with the interest rate  
[00:18:45] so the same thing put a little bit differently  
[00:18:48] in graph terms  
[00:18:50] so what's here on the left is essentially  
[00:18:53] the traditional view of monetary policy  
[00:18:56] and that is there's a down  
[00:18:58] these graphs essentially plot the interest rates  
[00:19:00] against the quantity of money  
[00:19:02] and in blue and I don't know how to  
[00:19:06] do anything  
[00:19:08] in blue here that is the supply curve  
[00:19:12] and in the other blue  
[00:19:14] strikingly similar unfortunately  
[00:19:16] is the demand curve  
[00:19:18] and so the traditional view of monetary policy  
[00:19:22] therefore is as the central bank acts  
[00:19:25] injects money into the economy  
[00:19:27] the supply curve would shift out  
[00:19:29] since demand is traditionally unaffected  
[00:19:32] we're at a lower interest rate  
[00:19:34] and that has all the stimulating effects  
[00:19:37] now that we would argue  
[00:19:40] is not always true  
[00:19:42] it depends very much on the extent  
[00:19:44] to which borrowing is difficult in the first place  
[00:19:47] on the severity of this financing friction  
[00:19:51] so take a second sector  
[00:19:54] there which illustrates now how supply does  
[00:19:57] or could affect demand  
[00:19:59] as the supply curve shifts out  
[00:20:05] demand is affected and so the demand curve  
[00:20:07] also shifts out  
[00:20:09] and depending on how strongly demand  
[00:20:11] responds to this extra supply  
[00:20:14] we could end up in a situation  
[00:20:16] where the interest rate is actually higher  
[00:20:18] than it was before we instituted the policy  
[00:20:22] and so what I'm trying to highlight here  
[00:20:24] sector one and sector two I guess  
[00:20:26] are stand-in names for sector one  
[00:20:28] a sector that is harder to lend to  
[00:20:31] the demand does not respond  
[00:20:33] as easily to the policy  
[00:20:37] and sector two  
[00:20:39] a sector in which when you pour in money  
[00:20:42] people will actually use this money  
[00:20:45] in some way and that might lead  
[00:20:47] to an increase in the asset price  
[00:20:49] and therefore in an increase  
[00:20:51] in the effective demand for money  
[00:20:53] okay and so you would think  
[00:20:55] that's even though the interest rate  
[00:20:57] may go up that may not always be a bad thing  
[00:20:59] since the collateral value has gone up  
[00:21:01] that is an opposing force  
[00:21:03] and how people can now go about boring  
[00:21:05] and so I guess what I'm gonna  
[00:21:08] you can probably guess what I'm about to do  
[00:21:10] I'm about to argue that sector one  
[00:21:12] for some reason will look like  
[00:21:14] the real economy and sector two  
[00:21:16] like commodities, the stock market  
[00:21:19] and all the other ones I had up there earlier  
[00:21:22] and so the main idea is I guess that  
[00:21:24] what differentiates these two places  
[00:21:26] is the degree, the severity  
[00:21:28] of the financing friction  
[00:21:30] okay, alright  
[00:21:32] but that's true I guess  
[00:21:34] for any one sector on its own  
[00:21:37] but of course they don't exist in a vacuum  
[00:21:39] an economy they compete for money  
[00:21:41] and so if you put them together  
[00:21:44] that is I guess our attempt  
[00:21:47] at the explanation of why credit  
[00:21:49] might not have ended up in the right place  
[00:21:52] and that is what we call I guess  
[00:21:54] this crowding out effect  
[00:21:56] the fact that if you inject money  
[00:21:58] some sectors actually receive  
[00:22:00] or are able to borrow less money  
[00:22:02] they end up with less money, less credit  
[00:22:04] than they would have ended up with  
[00:22:06] before you put money into the economy  
[00:22:08] so just the opposite of what you might have expected  
[00:22:11] and so to see this  
[00:22:14] I'm still struggling with these two buttons  
[00:22:16] not sure why  
[00:22:18] so think that initially in the economy  
[00:22:20] we had a total amount of money  
[00:22:22] in the economy of Q1  
[00:22:24] which ended up sitting in sector one  
[00:22:27] that's this little bit  
[00:22:29] plus a quantity Q2  
[00:22:32] okay that's the total amount of money  
[00:22:34] in the economy that ended up sitting  
[00:22:36] in these two sectors  
[00:22:37] now the central band starts  
[00:22:39] with a further amount  
[00:22:41] and the further amount  
[00:22:43] given what I just showed you on the other slide  
[00:22:45] apparently could shift out  
[00:22:47] the demand curve  
[00:22:49] make the sector two  
[00:22:51] or stimulate sector two more  
[00:22:53] to the extent that the interest rate  
[00:22:55] actually decreases  
[00:22:57] and at that higher interest rate  
[00:22:59] the only way this credit market could clear  
[00:23:01] is now such that  
[00:23:03] there is actually less money  
[00:23:05] that flows into sector one  
[00:23:07] that gets taken out  
[00:23:09] and pumped back into sector two  
[00:23:11] in fact it's worse than that  
[00:23:13] that it kind of feeds on itself  
[00:23:15] and so the reason is that  
[00:23:17] in sector one  
[00:23:19] once you put money in  
[00:23:21] because the collateral value  
[00:23:23] in sector one does not respond as much  
[00:23:26] but it did respond in sector two  
[00:23:28] in sector two all these firms  
[00:23:30] that are now stimulated  
[00:23:32] where the money is flowing into  
[00:23:34] they see the value of their investments  
[00:23:36] that are being productively pursued  
[00:23:39] appreciate  
[00:23:41] that increases the collateral value  
[00:23:43] which means that more people  
[00:23:45] more firms in this sector  
[00:23:46] now qualify to borrow  
[00:23:48] they can borrow  
[00:23:49] which increases the demand  
[00:23:51] the competition for money  
[00:23:53] therefore when the competition  
[00:23:55] for money goes up  
[00:23:56] clearly the interest rate  
[00:23:57] that banks can get away with charging  
[00:23:59] goes up  
[00:24:00] but since of course  
[00:24:01] any firm in the marketplace  
[00:24:03] competes for this money  
[00:24:05] firms from sector one  
[00:24:07] that did not see the appreciation  
[00:24:09] of the collateral value  
[00:24:10] but are now faced with a higher interest rate  
[00:24:13] so those terms the bank says  
[00:24:15] well if my risk is higher  
[00:24:18] the collateral value is not as high  
[00:24:21] and I have to live with a higher interest rate  
[00:24:23] well I'm not going to lend as much to sector one  
[00:24:26] so they might have received  
[00:24:27] a hundred million dollars  
[00:24:28] before the stimulus  
[00:24:29] after this excessive stimulus  
[00:24:31] they may only receive 80 million  
[00:24:33] the extra 20 go into sector two  
[00:24:37] and that may then therefore  
[00:24:38] further appreciate  
[00:24:40] lead to further investments  
[00:24:41] further appreciate the collateral value  
[00:24:43] lead to further relaxation  
[00:24:45] of these borrowing constraints  
[00:24:47] further competition for money  
[00:24:49] interest rate goes up  
[00:24:50] and that crowds out  
[00:24:52] more money out of the initial sector  
[00:24:56] okay  
[00:24:57] and so I realize  
[00:24:58] I'm probably jumping a little bit ahead of myself  
[00:25:00] but  
[00:25:02] and you can see now  
[00:25:03] I guess I'm happy to say this now  
[00:25:05] that one thing you can of course see  
[00:25:08] why that may  
[00:25:09] that in itself of course is a market failure  
[00:25:12] there is an externality from sector two  
[00:25:15] to sector one  
[00:25:17] sector two attracting the money  
[00:25:19] hurts sector one  
[00:25:21] because they get as a result of  
[00:25:23] the first one getting the money  
[00:25:24] get less money  
[00:25:25] so now if you imagine  
[00:25:27] what if sector one  
[00:25:28] were actually the more productive sector  
[00:25:30] the real economy  
[00:25:32] but they're just  
[00:25:34] harder to finance  
[00:25:35] think of maybe a pharmaceutical company  
[00:25:37] that if they want to  
[00:25:39] come up with a new blockbuster drug  
[00:25:41] but when they go to the banker  
[00:25:43] and say hey can I please have a loan  
[00:25:45] and he says well what can you secure the loan with  
[00:25:47] and they say well at this moment  
[00:25:49] nothing but a good idea  
[00:25:50] of course exaggerating here  
[00:25:52] but that is sort of one  
[00:25:54] way to think about this  
[00:25:56] and therefore you could see that  
[00:25:58] it might be not a good thing  
[00:26:00] for the economy as a whole  
[00:26:01] if the productive sectors  
[00:26:03] end up being the ones that are hardest to lend to  
[00:26:06] okay so  
[00:26:09] I feel like I've already said what's on this slide  
[00:26:12] but let me since this was fairly high level here  
[00:26:14] let me try to therefore  
[00:26:16] I guess get to the concrete point  
[00:26:18] that makes these two sectors  
[00:26:20] that I've sort of described  
[00:26:22] with the real economy  
[00:26:23] and commodity markets and so forth  
[00:26:25] generally speaking  
[00:26:26] what really is I guess  
[00:26:28] the difference between them  
[00:26:30] and to us the difference  
[00:26:32] is as I said the severity  
[00:26:34] of the financing friction  
[00:26:36] and in our argument this comes from  
[00:26:38] the fundamental nature  
[00:26:40] of these assets  
[00:26:43] in the sector over here  
[00:26:46] that is apparently  
[00:26:48] easier to lend to  
[00:26:50] we would call these assets  
[00:26:52] less specific  
[00:26:54] another way of saying  
[00:26:55] there are probably many more  
[00:26:57] potential users of these assets  
[00:26:59] that would be  
[00:27:00] if they were put up for sale  
[00:27:02] be willing to use these more  
[00:27:04] and therefore be willing to pay more  
[00:27:06] for these assets  
[00:27:07] than in sector one  
[00:27:09] so take maybe an egregious case  
[00:27:11] that of a house  
[00:27:12] you don't probably have to be an expert  
[00:27:14] to know how to live in a house  
[00:27:16] or buy one  
[00:27:18] but in order to operate the machinery  
[00:27:20] of a specialized car maker  
[00:27:22] that only can make cars  
[00:27:25] by that car maker  
[00:27:27] you probably won't find as many people  
[00:27:29] as many firms interested in buying  
[00:27:31] the machinery of that car maker  
[00:27:33] if that car maker were to go belly up  
[00:27:35] the bank were to seize the collateral  
[00:27:37] and then try to find a buyer  
[00:27:39] in that market probably the future market price  
[00:27:41] won't be able to find as many buyers  
[00:27:43] won't be able to fetch as high a price  
[00:27:45] and that is to us what  
[00:27:47] in our argument what differentiates  
[00:27:49] these two sectors  
[00:27:50] commodities, the stocks  
[00:27:52] financial securities  
[00:27:54] and commodities by their very name  
[00:27:56] they're commoditized  
[00:27:57] have in common  
[00:27:58] they're a lot less specific  
[00:28:00] in their usage  
[00:28:01] interpretation might require  
[00:28:03] a lot less expertise perhaps  
[00:28:05] then how to operate  
[00:28:07] and derive value from  
[00:28:08] specific machinery for instance  
[00:28:11] and so what that  
[00:28:13] in some sense highlights is that  
[00:28:15] as you can see or as I'm trying to  
[00:28:17] indicate with these graphs here  
[00:28:19] is that money by itself  
[00:28:21] is hurtful  
[00:28:22] but before we even get there  
[00:28:24] money by itself cannot solve the problem  
[00:28:26] right even if you  
[00:28:28] even if there were only one sector  
[00:28:30] Q1 if you poured  
[00:28:32] nothing but money flooded the  
[00:28:34] sector with money  
[00:28:35] apparently according to our argument  
[00:28:37] that collateral value might not respond  
[00:28:39] all that much  
[00:28:40] and you might not get this favorable multiplier effect  
[00:28:43] so there is something more fundamental  
[00:28:45] that anchors and therefore  
[00:28:48] potentially also limits  
[00:28:50] the effectiveness of policy  
[00:28:52] and that is the fundamental value of these assets  
[00:28:54] which in our  
[00:28:56] story here depend on how specific they are  
[00:28:59] it is the specificity that really makes people  
[00:29:01] later on be able to use them  
[00:29:03] to a higher and more effective extent  
[00:29:06] that will keep the future asset price  
[00:29:08] either higher or not  
[00:29:10] and therefore the bank internalizes and says  
[00:29:12] well if the loan were to go belly up  
[00:29:14] and I can't sell this asset for a high price  
[00:29:16] I'm not willing to lend as much  
[00:29:18] to this sector today  
[00:29:20] okay  
[00:29:24] right I feel like I've already said this  
[00:29:26] but therefore what does optimal policy  
[00:29:28] therefore look like  
[00:29:30] so our argument is that  
[00:29:32] we're not trying to suggest that  
[00:29:34] monetary policy would not  
[00:29:36] probably be a good place to do this in this crowd  
[00:29:38] be a bad thing  
[00:29:40] what we're trying to suggest is that  
[00:29:42] excessive monetary policy  
[00:29:44] might come  
[00:29:46] at a cost  
[00:29:48] and so one way to see this is in this graph  
[00:29:50] I've just put these graphs together  
[00:29:52] to show this maybe a little more succinctly  
[00:29:54] so  
[00:29:56] imagine again that we're in a case where  
[00:29:58] the amount of money in the economy is q1  
[00:30:00] this bit  
[00:30:02] plus q2 which is that bit  
[00:30:04] and they're somehow initially allocated  
[00:30:06] across these two sectors  
[00:30:08] and now the central bank wants to inject money again  
[00:30:10] and that money  
[00:30:12] initially will flow to both sectors  
[00:30:14] but at some point  
[00:30:16] in fact I picked that point judiciously  
[00:30:18] at q1 plus q2  
[00:30:20] that is the optimum  
[00:30:22] because as you start to inject further money  
[00:30:24] that money will flow  
[00:30:26] to sector 2  
[00:30:28] which we'll see its collateral value appreciate  
[00:30:30] end up clearing  
[00:30:32] the credit market at a high interest rate  
[00:30:34] crowd out sector 1  
[00:30:36] well that money that market has to clear  
[00:30:38] where is that money gonna go it's gonna go to sector 2  
[00:30:40] and so forth  
[00:30:42] so there is a benefit clearly  
[00:30:44] both sectors will  
[00:30:46] will be helped  
[00:30:48] by the policy to an extent  
[00:30:50] when  
[00:30:52] you haven't exhausted the optimum amount everybody  
[00:30:54] will get money and that will be a good thing  
[00:30:56] it's just when you push beyond  
[00:30:58] this bliss point which of course in practice  
[00:31:00] don't ask me for a number  
[00:31:02] or anything here but in practice of course  
[00:31:04] is a difficult thing to figure out  
[00:31:06] but we are arguing that the  
[00:31:08] excessive monetary policy  
[00:31:10] QE34567  
[00:31:12] in fact  
[00:31:14] might actually be more  
[00:31:16] ineffective than helpful  
[00:31:18] and so let me  
[00:31:20] end with maybe I guess  
[00:31:22] putting that into words  
[00:31:24] so we want to argue that  
[00:31:26] in some sense tempered monetary policy  
[00:31:28] that  
[00:31:30] does get implemented through the market where you give money  
[00:31:32] to the banks in the hope that they  
[00:31:34] put it in the right places is effective  
[00:31:36] that can stimulate the economy  
[00:31:38] but it's the excessive kind  
[00:31:40] that  
[00:31:42] actually distorts the credit market  
[00:31:44] in fact the credit market will give you the wrong signal  
[00:31:46] it'll sell  
[00:31:48] in some sense it'll tell you that one sector  
[00:31:50] is more worthwhile of investment  
[00:31:52] but that is in fact what is hurtful  
[00:31:54] to other sectors and clearly the  
[00:31:56] individual market participant doesn't care about that  
[00:31:58] but and therefore the  
[00:32:00] that is the market failure that undermines  
[00:32:02] this type of policy  
[00:32:04] and therefore that suggests there is  
[00:32:06] perhaps a limit to thinking  
[00:32:08] about  
[00:32:10] this very blunt policy just  
[00:32:12] giving money bluntly  
[00:32:14] and hoping it's going to end up in the right places  
[00:32:16] since it's not as fine  
[00:32:18] tuned might have these distorting  
[00:32:20] effects and therefore to understand  
[00:32:22] this it seems we  
[00:32:24] may have to go back and try to understand  
[00:32:26] the nuances of what  
[00:32:28] really explain the market failure that  
[00:32:30] justify the policy in the first place  
[00:32:32] to really try to understand  
[00:32:34] what the optimal policy  
[00:32:36] design should be and  
[00:32:38] specifically in our case I guess that meant  
[00:32:40] what really makes sectors  
[00:32:42] respond differently to the policy  
[00:32:44] that is I guess the culprit here  
[00:32:46] so I don't know how I'm  
[00:32:48] doing with time I forgot to time myself but  
[00:32:50] I'll stop here thank you very much  

## Discussion (00:32:52 – 00:53:32)

[00:32:52] so this was a real pleasure  
[00:33:00] to read this paper this was  
[00:33:02] I think  
[00:33:04] a paper that is  
[00:33:06] part of a growing  
[00:33:08] academic literature that's trying  
[00:33:10] to put a more rigorous  
[00:33:12] framework around  
[00:33:14] you know the the financial  
[00:33:16] sector and its interaction  
[00:33:18] with the real economy and  
[00:33:20] the you know the interaction  
[00:33:22] with policy and that is  
[00:33:24] indeed a worthy  
[00:33:26] goal because it's  
[00:33:28] obviously something that we're living with  
[00:33:30] we've been living with for a long time  
[00:33:32] and we're probably going to live with it for a lot  
[00:33:34] longer so the more we can  
[00:33:36] understand the essence  
[00:33:38] of what that interaction is  
[00:33:40] then you know  
[00:33:42] the better policy decisions we'll be  
[00:33:44] able to make and we've been sort of making things  
[00:33:46] up as we go along  
[00:33:48] and it's good to kind of  
[00:33:50] have these more  
[00:33:52] theoretical  
[00:33:54] explorations  
[00:33:56] the model creates  
[00:33:58] a very useful structure I think  
[00:34:00] for formalizing  
[00:34:02] a relationship between  
[00:34:04] credit availability  
[00:34:06] and asset valuations  
[00:34:08] solvency  
[00:34:10] he didn't go  
[00:34:12] Alex didn't go into detail  
[00:34:14] about you know some of the mechanisms  
[00:34:16] for why the central bank gets involved  
[00:34:18] but that is in the paper  
[00:34:20] and that that differs  
[00:34:22] across sectors and that  
[00:34:24] the idea of asset specificity  
[00:34:26] or financing frictions  
[00:34:28] and I think you know  
[00:34:30] to me very  
[00:34:32] productive to have that kind of  
[00:34:34] mechanism in an economic model  
[00:34:36] of a feedback  
[00:34:38] loop between the credit creation and the  
[00:34:40] asset valuations  
[00:34:42] clearly I think is something that  
[00:34:44] is a reality that  
[00:34:46] we live with and that the Fed has been interacting with  
[00:34:48] and so certainly  
[00:34:50] having that in the model  
[00:34:52] is I think quite productive and useful  
[00:34:54] as Alex noted  
[00:34:56] he does equate a lot of things  
[00:34:58] he equates liquidity  
[00:35:00] and  
[00:35:02] credit  
[00:35:04] and he specifically equates  
[00:35:06] central bank liquidity with  
[00:35:08] private bank credit  
[00:35:10] and I think that can  
[00:35:12] potentially lead us  
[00:35:14] astray in drawing policy inferences  
[00:35:16] and not astray  
[00:35:18] I mean I think I'm pretty sympathetic  
[00:35:20] to the policy conclusions that Alex draws  
[00:35:22] but I want to broaden  
[00:35:24] the discussion  
[00:35:26] to really kind of  
[00:35:28] look for  
[00:35:30] what is the broader framework  
[00:35:32] what is  
[00:35:34] what was the motivating  
[00:35:36] force that  
[00:35:38] led the Fed  
[00:35:40] or the ECB or the Bank of Japan  
[00:35:42] to  
[00:35:44] engage in these unconventional policies  
[00:35:46] so I'm going to do this  
[00:35:48] I'm going to discuss this  
[00:35:50] through a concept  
[00:35:52] the concept of financialization  
[00:35:54] and financialization is a term  
[00:35:56] that gets used like asset bubbles  
[00:35:58] it can mean a lot of different things  
[00:36:00] so to me  
[00:36:02] in spirit it means  
[00:36:04] it's a lot of what Alex  
[00:36:06] is trying to get at with his asset  
[00:36:08] specificity  
[00:36:10] so I'm going to define financialization as  
[00:36:12] when the exchange of goods  
[00:36:14] and services is increasingly facilitated  
[00:36:16] through financial instruments  
[00:36:18] so we've  
[00:36:20] seen that so financialization  
[00:36:22] allows you to exchange goods  
[00:36:24] and services  
[00:36:26] across different currencies  
[00:36:28] across time  
[00:36:30] across different states of the world  
[00:36:32] there's a lot of contingencies you can build  
[00:36:34] into financial contracts  
[00:36:36] that allow you to exchange goods  
[00:36:38] and services  
[00:36:40] and it also allows you to  
[00:36:42] borrow it allows you  
[00:36:44] to take assets  
[00:36:46] and turn them into credit  
[00:36:48] and liquidity and grow  
[00:36:50] and make decisions  
[00:36:52] and this has been  
[00:36:54] you know this has been something  
[00:36:56] that's been a trend  
[00:36:58] I'm going to call  
[00:37:00] I'm going to divide time between  
[00:37:02] the postwar period in 1980 and 1980 to now  
[00:37:04] and since 1980  
[00:37:06] we've seen  
[00:37:08] a rapid increase in financialization  
[00:37:10] as I define it and a rapid increase  
[00:37:12] in debt, debt to GDP  
[00:37:14] ratios  
[00:37:16] and that financialization  
[00:37:18] can in Alex's  
[00:37:20] framework  
[00:37:22] or similar to the framework he's modeling  
[00:37:24] it can amplify  
[00:37:26] a natural  
[00:37:28] speculative process  
[00:37:30] so I quote Keynes here because  
[00:37:32] still to me Keynes  
[00:37:34] Chapter 12 is one of the best descriptions  
[00:37:36] of how markets really work  
[00:37:38] and  
[00:37:40] and I often return  
[00:37:42] to it so  
[00:37:44] you know when you have  
[00:37:46] in a financialized world  
[00:37:48] he's writing in the aftermath  
[00:37:50] of the Great Depression  
[00:37:52] obviously the boom and bust  
[00:37:54] of the equity markets  
[00:37:56] he says when investing  
[00:37:58] the American is not attaching  
[00:38:00] his hopes to the investment's long-term  
[00:38:02] expected return but rather  
[00:38:04] to a favorable change in its short-term valuation  
[00:38:06] i.e. he is a  
[00:38:08] speculator now speculators may  
[00:38:10] do little or no harm when they're only bubbles  
[00:38:12] on a steady stream of long-term investors  
[00:38:14] they can be seriously harmful  
[00:38:16] when long-term investors become the bubble  
[00:38:18] on a whirlpool of speculators  
[00:38:20] and when the capital  
[00:38:22] of a development of a country  
[00:38:24] becomes a byproduct of activities  
[00:38:26] of a casino the job is not  
[00:38:28] likely to be well done  
[00:38:30] okay so what is Keynes talking about  
[00:38:32] Keynes really struggles  
[00:38:34] with the  
[00:38:36] speculative with liquidity  
[00:38:38] Keynes is talking about market liquidity  
[00:38:40] and he laments market liquidity  
[00:38:42] and the short-term  
[00:38:44] thinking that it can give rise  
[00:38:46] to but at the same  
[00:38:48] time he understands  
[00:38:50] that that very market  
[00:38:52] liquidity is bringing more capital  
[00:38:54] into the market  
[00:38:56] than would otherwise  
[00:38:58] enter the market and so  
[00:39:00] it's a trade-off and i think  
[00:39:02] this is really the spirit  
[00:39:04] so this is not new the financialization  
[00:39:06] and the  
[00:39:08] angst about the efficient allocation  
[00:39:10] of capital through liquid markets  
[00:39:12] this is something  
[00:39:14] we've been living with for a very long time  
[00:39:18] so  
[00:39:20] this is a debt to GDP  
[00:39:22] in the united states  
[00:39:24] since World War II  
[00:39:26] and this is all debt  
[00:39:28] so this is financial  
[00:39:30] private sector  
[00:39:32] and public sector  
[00:39:34] non-financial debt as a percent of GDP  
[00:39:36] so you can see that between  
[00:39:38] 1940s and 1980 we're kind of  
[00:39:40] on this gentle upward trend  
[00:39:42] from about 145% to 160%  
[00:39:44] and then after 1980  
[00:39:46] mid 80s we saw a big jump  
[00:39:48] up  
[00:39:50] and then another sort of upward drift  
[00:39:52] and then a sort of exponential  
[00:39:54] spike  
[00:39:56] up to 380%  
[00:40:00] so that's a pretty phenomenal  
[00:40:02] degree of financialization  
[00:40:04] and what are the drivers  
[00:40:06] where there's multiple drivers  
[00:40:08] floating currency regimes  
[00:40:10] after the collapse of Bretton Woods  
[00:40:12] facilitates easier money rather than  
[00:40:14] tighter money  
[00:40:16] technology and globalization  
[00:40:18] I remember when I was at the Federal Reserve Board  
[00:40:20] and we were looking at that  
[00:40:22] sort of level shift up in the mid 80s  
[00:40:24] we talked a lot about things like  
[00:40:26] credit scoring and the ability  
[00:40:28] to extend credit  
[00:40:30] to borrowers who previously were  
[00:40:32] constrained  
[00:40:34] to assess credit cheaply and easily  
[00:40:36] so that's technology  
[00:40:38] globalization  
[00:40:40] and the rise of China  
[00:40:42] so creating a large  
[00:40:44] and growing non-market economy  
[00:40:46] that's the savings glut  
[00:40:48] sort of channeling its reserves  
[00:40:50] back into markets  
[00:40:52] and then the deregulation of the financial system  
[00:40:54] and then I would say  
[00:40:56] when we're talking about monetary policy  
[00:40:58] the complacency of regulators  
[00:41:00] the faith  
[00:41:02] they put in the efficiency of markets  
[00:41:04] and the efficiency  
[00:41:06] of risk takers  
[00:41:08] to take risk well  
[00:41:10] and sort of the  
[00:41:12] the supremacy of the efficient markets  
[00:41:14] hypothesis over the kind of  
[00:41:16] imperfections that  
[00:41:18] Keynes was thinking of  
[00:41:20] and grappling with  
[00:41:22] and  
[00:41:24] since then  
[00:41:26] so obviously that was  
[00:41:28] an unsustainable degree of  
[00:41:30] financialization that led us to the  
[00:41:32] financial crisis  
[00:41:34] and I think what's really striking  
[00:41:36] for the United States we actually did  
[00:41:38] deliver  
[00:41:40] little bit and we've been  
[00:41:42] stable so it's kind of  
[00:41:44] remarkable that we've actually  
[00:41:46] achieved a recovery  
[00:41:48] through  
[00:41:50] some deregulation  
[00:41:52] pretty meaningful deregulation  
[00:41:54] this takes the same  
[00:41:56] debt to GDP ratio  
[00:41:58] to the different sectors  
[00:42:00] so the business  
[00:42:02] the non-financial business sector  
[00:42:04] the household sector on the top charts  
[00:42:06] and then the public sector  
[00:42:08] and then the financial sector  
[00:42:10] so I think a couple of interesting things  
[00:42:12] there  
[00:42:14] that the business borrowing  
[00:42:16] really didn't account for much of the leverage  
[00:42:18] overall  
[00:42:20] about 20 percentage points  
[00:42:22] of 220 percentage points  
[00:42:24] but what's interesting is that business borrowing  
[00:42:26] is a bit more cyclical  
[00:42:28] since 1980 so we actually  
[00:42:30] borrow and deleverage  
[00:42:32] and borrow and deleverage in the non-financial business sector  
[00:42:34] and that's a new dimension  
[00:42:36] of activity and of business cycles  
[00:42:38] the household sector was more  
[00:42:40] sort of an upward trend  
[00:42:42] and then a housing bubble  
[00:42:44] and then  
[00:42:46] the federal sector really wasn't part of  
[00:42:48] the leverage cycle  
[00:42:50] for a long long time until the crisis  
[00:42:52] and really you can see  
[00:42:54] the financial sector is phenomenal  
[00:42:56] it's more than half  
[00:42:58] of the total increase in overall  
[00:43:00] leverage in the economy  
[00:43:02] was the financial sector itself  
[00:43:04] and I think that's kind of what Alex has in mind  
[00:43:06] when he's thinking of that  
[00:43:08] asset specificity and maybe  
[00:43:10] he says it that maybe not  
[00:43:12] the most productive use of  
[00:43:14] credit is allocating it  
[00:43:16] to the financial sector  
[00:43:18] but what wasn't part of it  
[00:43:20] is the Fed  
[00:43:22] balance sheet and  
[00:43:24] it is not included in the debt to GDP  
[00:43:26] ratio because it's not debt  
[00:43:28] it is the central banks balance sheet  
[00:43:30] and  
[00:43:32] it was pretty much  
[00:43:34] doing nothing through this whole period  
[00:43:36] until the financial crisis  
[00:43:38] so a lot of the  
[00:43:40] inefficiencies that I think that Alex  
[00:43:42] is  
[00:43:44] focused on and models  
[00:43:46] well and I think some of the structures  
[00:43:48] of the model are very useful  
[00:43:50] they have nothing to do with the central bank  
[00:43:52] they have more to do  
[00:43:54] with financialization and the forces  
[00:43:56] that have led us here  
[00:43:58] so why is that important  
[00:44:00] well I think getting to the heart  
[00:44:02] of  
[00:44:04] these credit dynamics  
[00:44:06] and to the degree they're excessive  
[00:44:08] to the degree they're inefficient  
[00:44:10] understanding  
[00:44:12] why that is  
[00:44:14] and  
[00:44:16] how is the central bank involved  
[00:44:18] in this whole process  
[00:44:20] is important to drawing  
[00:44:22] the right policy conclusions  
[00:44:24] and especially now we are at  
[00:44:26] a crossroads and we've got some really big  
[00:44:28] decisions that the Fed is about to make  
[00:44:30] that could affect all of us in this room  
[00:44:32] in significant ways  
[00:44:34] so I think the paper very usefully  
[00:44:36] creates a structure  
[00:44:38] whereby access to credit  
[00:44:40] varies  
[00:44:42] differing according  
[00:44:44] to differing degrees of asset specificity  
[00:44:46] but  
[00:44:48] the mechanism  
[00:44:50] that the paper relies on  
[00:44:52] for perpetuating the inefficiencies  
[00:44:54] doesn't seem plausible  
[00:44:56] at least in the US context  
[00:44:58] and I don't, I think that there are  
[00:45:00] some very important distinctions between  
[00:45:02] the US  
[00:45:04] Fed stimulus  
[00:45:06] and China's stimulus  
[00:45:08] and the  
[00:45:10] in particular that the Fed  
[00:45:12] is going to stimulate so much borrowing  
[00:45:14] from one sector  
[00:45:16] that it crowds out another  
[00:45:18] in fact we've been deleveraging  
[00:45:20] we haven't been  
[00:45:22] this isn't about the credit channel  
[00:45:24] actually the credit channel has been  
[00:45:26] very very meager  
[00:45:28] in this cycle  
[00:45:30] the real channel of monetary policy  
[00:45:32] and  
[00:45:34] Trish I think stated this earlier  
[00:45:36] in her discussion  
[00:45:38] is the asset price channel  
[00:45:40] that's really been operative  
[00:45:42] balance sheets be they corporate balance sheets  
[00:45:44] through equity valuations  
[00:45:46] be they household balance sheets  
[00:45:48] were facilitating a deleveraging  
[00:45:50] this is not a credit cycle  
[00:45:54] and there's an important distinction  
[00:45:56] between liquidity and credit  
[00:45:58] you know when the Fed did extend  
[00:46:00] credit in the crisis they did  
[00:46:02] they lent money against collateral  
[00:46:04] and then it got paid back  
[00:46:06] that was bago style  
[00:46:08] emergency lending in a crisis  
[00:46:10] QE is very different  
[00:46:12] QE is not the creation of credit  
[00:46:14] it is  
[00:46:16] the creation of assets out of thin air  
[00:46:18] which the central bank can uniquely do  
[00:46:22] and it's only  
[00:46:24] taxes the only repayment is through  
[00:46:26] its effect on the value of the currency  
[00:46:28] the valuation of assets  
[00:46:32] and you know one of the conclusions  
[00:46:34] of the paper that Alex didn't get into in detail was  
[00:46:36] you know that some of the advantages  
[00:46:38] you know he sort of concludes that maybe  
[00:46:40] we don't want to rely too much on monetary  
[00:46:42] policy but more on fiscal  
[00:46:44] of course we want to get that balance right  
[00:46:46] and I think he does point out some  
[00:46:48] usefully some of the shortcomings  
[00:46:50] but there are some advantages  
[00:46:52] I mean there is a sort of a siren song  
[00:46:54] of fiscal policy right now  
[00:46:56] that fiscal policy if we could just get it  
[00:46:58] would solve a lot of problems  
[00:47:00] it's also going to create a lot more debt  
[00:47:02] and that has to be repaid by future generations  
[00:47:04] and if we look at our own electoral  
[00:47:06] politics and it's not exactly  
[00:47:08] like that leads to  
[00:47:10] always happy, efficient  
[00:47:12] peaceful outcomes  
[00:47:14] it can lead to a lot of upheaval  
[00:47:16] and difficulties  
[00:47:18] and clashes between sectors  
[00:47:20] and inefficiencies  
[00:47:22] are you giving me the sign  
[00:47:24] okay okay I'll finish up here  
[00:47:26] so I'm going to just wrap up  
[00:47:28] with a couple of things  
[00:47:30] I think that  
[00:47:32] you know the reality  
[00:47:34] is we're in a financialized world  
[00:47:36] we're also in a heavily indebted world  
[00:47:38] monetary policy worked  
[00:47:40] through different channels, through different mechanisms  
[00:47:42] because of that  
[00:47:44] that wasn't caused by the Fed  
[00:47:46] that was the Fed reacting  
[00:47:48] and I think that's really important to understand  
[00:47:50] because all those forces that led us to this world  
[00:47:52] are still out there  
[00:47:54] the chart I showed you with the US  
[00:47:56] deleveraging a bit  
[00:47:58] if you put this on the global scale  
[00:48:00] we haven't deleveraged at all  
[00:48:02] so we're still in this  
[00:48:04] financialized indebted world  
[00:48:06] we're going to be with these tools  
[00:48:08] for a long time  
[00:48:10] and  
[00:48:12] so I think  
[00:48:14] there is a reaction  
[00:48:16] on some observers  
[00:48:18] and certainly even among some monetary policy makers  
[00:48:20] to say ooh this yucky balance sheet  
[00:48:22] let's just get rid of it  
[00:48:24] let's just put it to the side  
[00:48:26] put it on all our pilot  
[00:48:28] we don't ever want to have to deal with it again  
[00:48:30] I nearly guarantee it  
[00:48:32] it's going to be there  
[00:48:34] it's going to be part of policy  
[00:48:36] and I'm just going to leave with one last thing  
[00:48:38] one last thing, the right hand chart  
[00:48:40] I want to, so the left hand side shows  
[00:48:42] that we're not unique in this of course  
[00:48:44] the right hand chart  
[00:48:46] shows you two measures  
[00:48:48] one is  
[00:48:50] stock market capitalization to GDP  
[00:48:52] as a percent of GDP, good old flow of funds measure  
[00:48:54] doesn't have Q1  
[00:48:56] because we don't have Q1 flow of funds yet  
[00:48:58] but we do  
[00:49:00] that baby is going to a new all-time high  
[00:49:02] and so that would say  
[00:49:04] holy smokes  
[00:49:06] that's pretty bubble-ish  
[00:49:08] and  
[00:49:10] then the green line though  
[00:49:12] is the Schiller cyclically adjusted  
[00:49:14] PE ratio  
[00:49:16] so this takes into account inflation  
[00:49:18] it takes into account  
[00:49:20] the discount rate  
[00:49:22] haha  
[00:49:24] that is very key  
[00:49:26] one of the two measures is the discount rate  
[00:49:28] you're using  
[00:49:30] to discount future earning streams  
[00:49:32] so with low interest rates  
[00:49:34] uses the 10-year treasury yield  
[00:49:36] low 10-year interest rates  
[00:49:38] you know the stock market doesn't look  
[00:49:40] quite so overvalued  
[00:49:42] this is what I want to end with  
[00:49:44] the question confronting the Fed now  
[00:49:46] with its balance sheet  
[00:49:48] is all about that differential  
[00:49:50] the Fed shows nice charts  
[00:49:52] about how much term-premia subsidy  
[00:49:54] they've given through their balance sheet  
[00:49:56] well it's not just affecting  
[00:49:58] treasury yields  
[00:50:00] it's affecting all  
[00:50:02] if you change it  
[00:50:04] it's going to affect  
[00:50:06] all valuations  
[00:50:08] and you need to think about that  
[00:50:10] and not just model the term-premia  
[00:50:12] but it's ripple effect through all assets  
[00:50:14] so it's going to be  
[00:50:16] and the Fed has this  
[00:50:18] concept of our star  
[00:50:20] the neutral equilibrium  
[00:50:22] funds rate  
[00:50:24] what is balance sheet star  
[00:50:26] if there's an R start  
[00:50:28] there's a balance sheet star  
[00:50:30] you're getting a certain amount of  
[00:50:32] accommodation from the balance sheet  
[00:50:34] it's a tool of policy  
[00:50:36] what's neutral  
[00:50:38] do you know what it is  
[00:50:40] so that's something that I think  
[00:50:42] we need to incorporate into  
[00:50:44] thinking and calibrating  
[00:50:46] and looking at the future  
[00:50:48] and not just saying  
[00:50:50] let's just get rid of this  
[00:50:52] as soon as possible because the world  
[00:50:54] that led to this is still the world  
[00:50:56] we live in  
[00:51:06] so we have much more  
[00:51:08] questions than we have time  
[00:51:10] so I'm going to combine several of them  
[00:51:12] the first one  
[00:51:14] that I want to deal with  
[00:51:16] there was a variety of  
[00:51:18] questions here kind of arguing  
[00:51:20] with well does this really describe  
[00:51:22] what's happened in the U.S.  
[00:51:24] especially post crisis  
[00:51:26] but I'm going to back it up  
[00:51:28] to the more general question  
[00:51:30] of when does  
[00:51:32] liquidity become excessive  
[00:51:34] and I realize the graphs  
[00:51:36] aren't going to tell you but  
[00:51:38] you're now in a policy position  
[00:51:40] and you have to judge  
[00:51:42] what do you look at  
[00:51:44] can it take a mulligan  
[00:51:46] well I guess  
[00:51:48] if you take the theory  
[00:51:50] seriously  
[00:51:52] I mean the nice thing I think  
[00:51:54] of being at a conference like this  
[00:51:56] I think was also dinner yesterday  
[00:51:58] and I said  
[00:52:00] in between two people  
[00:52:02] that knew each other quite intimately well  
[00:52:04] but came from different places  
[00:52:06] and I just realized that  
[00:52:08] just how difficult the job of a  
[00:52:10] policy maker really is  
[00:52:12] so I guess what the theory  
[00:52:14] would say is that  
[00:52:16] not only do you need to check one market  
[00:52:18] in our case  
[00:52:20] not just the credit market  
[00:52:22] you also should check the asset market  
[00:52:24] but not just the asset in the credit market  
[00:52:26] you need to do this  
[00:52:28] potentially for several asset markets  
[00:52:30] and so to get the full  
[00:52:32] brunt of the picture  
[00:52:34] to conclude  
[00:52:36] whether there is excess  
[00:52:38] liquidity  
[00:52:40] it takes quite a broad  
[00:52:42] picture of things but  
[00:52:44] if you take the model quite literally  
[00:52:46] it would say  
[00:52:48] if you look at what the indications might be  
[00:52:50] if you see a rise in asset price  
[00:52:52] in some place of the economy  
[00:52:54] but not in others  
[00:52:56] where there are signs that people do want to borrow  
[00:52:58] but there is no response  
[00:53:00] to the asset price that might be one  
[00:53:02] and of course the interest rate by itself  
[00:53:04] so  
[00:53:06] one thing of course that comes out of this  
[00:53:08] is that if there is too much money put in  
[00:53:10] in fact the interest rate just goes the wrong way  
[00:53:12] so  
[00:53:14] in other words the credit market  
[00:53:16] and in the multiple  
[00:53:18] asset markets you might have  
[00:53:20] to bear in mind  
[00:53:22] to be able to draw a conclusion  
[00:53:24] about whether there is excess liquidity  
[00:53:26] in the system  
[00:53:28] so  
[00:53:30] you've got a pretty stylized model  

## Q&A (00:53:32 – 01:01:44)

[00:53:32] and there's a couple of questions that  
[00:53:34] get at essentially the same issue  
[00:53:36] in a slightly different way  
[00:53:38] and this question was  
[00:53:40] would the results change if you have a heterogeneous bank  
[00:53:42] and some of them are more specialized  
[00:53:44] in the last collateral available sector  
[00:53:46] and  
[00:53:48] there's also one that  
[00:53:50] said  
[00:53:52] couldn't maybe the firm solve this  
[00:53:54] so  
[00:53:56] is this necessarily  
[00:53:58] are there ways  
[00:54:00] other ways that the private sector could have  
[00:54:02] and arguably should have  
[00:54:04] solved the problem  
[00:54:06] I already forgot the first one  
[00:54:08] but very good question  
[00:54:10] so I guess one thing that  
[00:54:12] may benefit from  
[00:54:14] question number two is that  
[00:54:16] I guess one thing that I like to think about is  
[00:54:18] what the limits  
[00:54:20] of using the market are for various purposes  
[00:54:22] and so the second question  
[00:54:24] relates to this which is  
[00:54:26] you typically think our responses  
[00:54:28] most things intuitively you want to  
[00:54:30] delegate to the market and then only if the market  
[00:54:32] has a problem we have fixes  
[00:54:34] like regulation  
[00:54:36] but the other solution to the market failure is  
[00:54:38] the firm itself  
[00:54:40] so I think it's a very much  
[00:54:42] open question to what extent  
[00:54:44] a market failure is often  
[00:54:46] better solved by a firm  
[00:54:48] expanding  
[00:54:50] let's say and internalizing  
[00:54:52] the problem versus  
[00:54:54] the policymaker necessarily being burdened  
[00:54:56] with this and of course  
[00:54:58] like I learned at dinner yesterday  
[00:55:00] if you have multiple policies  
[00:55:02] you have to think about how they interact much like here  
[00:55:04] if you have two solutions in how they interact  
[00:55:06] I mean I don't think  
[00:55:08] in academia  
[00:55:10] I don't want to speak that broadly but I haven't seen  
[00:55:12] that much work on exactly  
[00:55:14] that question  
[00:55:16] but if you just look at the let's say the data  
[00:55:18] it might paint  
[00:55:20] a very different picture so of course  
[00:55:22] coming out of the crisis we've seen that there's been  
[00:55:24] much more of a concentration in the banking sector  
[00:55:26] and most people would have said  
[00:55:28] that's a bad thing  
[00:55:30] now we're even bigger  
[00:55:32] too big  
[00:55:34] and even bigger too whatever that is  
[00:55:36] I wish bigger to fail  
[00:55:38] but maybe that was the natural  
[00:55:40] rational response that the bigger bank  
[00:55:42] in fact subsumes some of the problems  
[00:55:44] that  
[00:55:46] could not have been as efficiently addressed  
[00:55:48] or weren't addressed by the policy  
[00:55:50] now but let me ask  
[00:55:52] try to address this specifically  
[00:55:54] so there was  
[00:55:56] just to clarify  
[00:55:58] so if you're saying  
[00:56:00] why can't we essentially  
[00:56:02] in some sense have information  
[00:56:04] about firms in both markets  
[00:56:06] is that how you would rate that question  
[00:56:08] seems to be you have a  
[00:56:10] single bank in your model  
[00:56:12] and it's specialized  
[00:56:14] it operates in both sectors  
[00:56:16] if you had specialist banks  
[00:56:18] maybe this is less of a problem  
[00:56:20] I see, yeah so  
[00:56:22] good question  
[00:56:24] now of course the model as  
[00:56:26] people have already noted is somewhat stylized  
[00:56:28] so what makes this  
[00:56:30] I guess the fundamental  
[00:56:32] what makes the mechanism work is that  
[00:56:34] there is some link  
[00:56:36] between different sectors  
[00:56:38] boring in a common credit market  
[00:56:40] no doubt  
[00:56:42] of course is there differentiation  
[00:56:44] in the real world among  
[00:56:46] firms in any given sector  
[00:56:48] and across sectors  
[00:56:50] so our mechanism I guess is at work  
[00:56:52] and you would expect that there if there's of course  
[00:56:54] a common component  
[00:56:56] like a common price of money that  
[00:56:58] nobody can escape from  
[00:57:00] the price of intermediation  
[00:57:02] of credit across the economy  
[00:57:04] across sectors  
[00:57:06] so some sectors might of course  
[00:57:08] slightly have different spreads  
[00:57:10] they might respond somewhat differently  
[00:57:12] but to the extent that there's a common component  
[00:57:14] that is what could create the link  
[00:57:16] so clearly we're simplifying here  
[00:57:18] so it would be my response there  
[00:57:20] and so that therefore tells you  
[00:57:22] back to the first question  
[00:57:24] what would give you the indication of an excess  
[00:57:26] well if you do find a  
[00:57:28] commonality in the response  
[00:57:30] in credit across the sectors  
[00:57:32] even though they may respond somewhat differently  
[00:57:34] but there is an upward shift  
[00:57:36] some may move upward more than others  
[00:57:38] and so forth  
[00:57:40] it's the commonality  
[00:57:42] but I don't know if I answered the first question  
[00:57:44] I have to admit I did forget it  
[00:57:46] yeah  
[00:57:48] I think the first question  
[00:57:50] was as firms could  
[00:57:52] have the collateral  
[00:57:54] and borrow based on  
[00:57:56] general purpose collateral  
[00:57:58] yeah that's right so the underlying assumption  
[00:58:00] of course in some sense  
[00:58:02] what makes a sector  
[00:58:04] and so  
[00:58:06] you would think the initial state  
[00:58:08] here is that  
[00:58:10] whoever is the most efficient user  
[00:58:12] of a particular source of  
[00:58:14] real capital the machines  
[00:58:16] versus land or commodities  
[00:58:18] is the one that is willing to pay  
[00:58:20] most for it and therefore you would expect  
[00:58:22] if things are not too bad  
[00:58:24] there will be guys that end up using  
[00:58:26] and having that capital  
[00:58:28] and therefore that is what defines  
[00:58:30] the sector  
[00:58:32] so in other words even if you had  
[00:58:34] something that is used by multiple sectors  
[00:58:36] there's got to be  
[00:58:38] some core type of investment  
[00:58:40] that some sectors can use  
[00:58:42] more productively than others  
[00:58:44] and you would expect therefore that these sectors  
[00:58:46] therefore specialize in that  
[00:58:48] that would be my answer to that  
[00:58:50] yeah okay  
[00:58:52] my recollection is  
[00:58:54] that in Japan before their blow up  
[00:58:56] that a lot of the lending  
[00:58:58] was land based  
[00:59:00] yes  
[00:59:02] so that might buy you  
[00:59:04] a little bit but  
[00:59:06] I'll ask one last question  
[00:59:08] because we are pretty much out of time  
[00:59:10] kind of is the solution then  
[00:59:12] doing  
[00:59:14] some sort of central banks  
[00:59:16] targeting  
[00:59:18] their lending facilities  
[00:59:20] targeting  
[00:59:22] targeting a sector  
[00:59:24] yeah I mean you could say  
[00:59:26] we'll lend you money on  
[00:59:28] it means Teltro  
[00:59:30] yeah I'm not sure  
[00:59:32] I think it's Teltro right  
[00:59:34] it was this autocorrect  
[00:59:36] yeah  
[00:59:38] Teltro right  
[00:59:40] Teltro  
[00:59:42] yeah we know what Teltro  
[00:59:44] autocorrects to  
[00:59:46] so  
[00:59:50] so can I interpret that as the  
[00:59:52] sectoral  
[00:59:54] the central bank somehow targeting  
[00:59:56] its credit  
[00:59:58] to a particular sector  
[01:00:00] yeah so  
[01:00:02] right  
[01:00:04] so  
[01:00:06] the  
[01:00:08] yeah I would think so  
[01:00:10] so I mean I don't think there's  
[01:00:12] an easy general answer to this  
[01:00:14] but I guess  
[01:00:16] viewed through  
[01:00:18] the model  
[01:00:20] you would think  
[01:00:22] if you could do something  
[01:00:24] let's say if you have an indication  
[01:00:26] that one sector tends to get out of  
[01:00:28] whack yeah maybe there is  
[01:00:30] a point in reducing  
[01:00:32] the credit to this sector  
[01:00:34] and maybe giving it to the other  
[01:00:36] but it is a  
[01:00:38] double-edged sword I mean that's what I was trying to  
[01:00:40] highlight with the slide about the  
[01:00:42] this policy which is  
[01:00:44] suppose the extreme case in which  
[01:00:46] sector the first sector that doesn't get  
[01:00:48] the money in fact is the one that  
[01:00:50] shouldn't get the money it does not look like the  
[01:00:52] worthwhile sector  
[01:00:54] does the central bank have the better information  
[01:00:56] about that or the individual  
[01:00:58] highly specialized commercial  
[01:01:00] bank and therefore you  
[01:01:02] by trying to  
[01:01:04] undermine the problem that we highlight you invite  
[01:01:06] another which is maybe  
[01:01:08] misallocation of a different sword  
[01:01:10] even more practically do they have the legal  
[01:01:12] ability to do so  
[01:01:14] most of the time the answer is no  
[01:01:16] and even if they have it do they have the  
[01:01:18] political ability  
[01:01:20] so you're not going to provide funding  
[01:01:22] to house ring  
[01:01:24] lending most to the  
[01:01:26] countries that need it most well  
[01:01:28] that's proved to be have constitutional  
[01:01:30] issues and you know there's all kinds  
[01:01:32] of practical legal  
[01:01:34] constraints  
[01:01:36] with that I'd like to say  
[01:01:38] thank you very much  
[01:01:40] thank you  
[01:01:42] Julia