What does Osborne mean?

On Monday, George Osborne made an interesting speech. It would have been a good opening statement at a dinner party of economists. There was a lot to chew on but the ideas were ill defined. But they were the sort of ideas that, by the cheese course, might have led to something sensible arising from discussion. Let’s just take two of the statements:

“Everyone agrees that we need to develop better market infrastructure to minimise counterparty risk, reform the rating agencies and ensure pay structures don’t prioritise short-term risks over long-term sustainability.”

This brings to mind Hayek’s question of “who plans?” (as well as several other questions). Who is “we”? Is a future Conservative government (if that is what he means by “we”?) going to reform the pay structures of banks?

Adair Turner has made the quite sensible point that a regulator might want to give banks a higher regulatory capital requirement if their pay structures seem to encourage risk taking (though why not just focus on the risks that the bank has actually taken?). But should a future Conservative government be determining the pay structures of banks? Surely not.

Regarding the rating agencies, these are not the government’s creation and reform is none of its business. Rating agencies exist to lower the cost of capital to companies by publishing an informed opinion on their debt. Regulators have distorted rating agency incentives by lowering capital requirements for company debt which is held by banks and which has a good rating. I say, let’s get rid of those distorted incentives.

Osborne also thinks that market counterparty risk is a matter for the government. Markets are quite capable of developing institutions to deal with counterparty risk. It is not the government’s job. What is a problem is the lack of an orderly wind up when a counterparty fails and counterparties of counterparties are found to be in the banking system. Yes, the government should review its failure regime for banks (I believe there is a bill before Parliament now) but this is a separate matter.

Equally obscure on face value, but to a degree explained later in the speech, was the statement “We believe government should take a view on asset prices and seek to manage the overall level of debt in an economy.”  A mechanism involving the Bank of England and the FSA working together to tweak capital requirements was proposed. But maybe it would be best to make sure that central banks do not print too much money and create booms. 

The central bank focused on a narrow measure of inflation (imposed by government) and got it wrong. Osborne should just give the Bank of England a remit to target a widely-defined measure of inflation (or the price level) and put some people on the MPC who believe that money matters when judging the future course of inflation.

As President Obama has just illustrated the question of who should determine the pay structure of banks becomes more complex when the banks have just received millions of pounds or dollars of government (sic) money; a good case can be made that this money should not be paid to executives in large salaries or bonuses (good enough to convince your average financial journalist at least). But this is a classic example of the problems caused by government intervention; as Mises and Hayek warned, one intervention always begets more intervention, producing a vicious circle of more and more intervention.

John is quite right here, but the question then becomes ‘how can one ever stop the cycle of intervention?’ How many politicians are prepared to introduce the necessary ’shock therapy’?

As President Obama has just illustrated the question of who should determine the pay structure of banks becomes more complex when the banks have just received millions of pounds or dollars of government (sic) money; a good case can be made that this money should not be paid to executives in large salaries or bonuses (good enough to convince your average financial journalist at least). But this is a classic example of the problems caused by government intervention; as Mises and Hayek warned, one intervention always begets more intervention, producing a vicious circle of more and more intervention.

John is quite right here, but the question then becomes ‘how can one ever stop the cycle of intervention?’ How many politicians are prepared to introduce the necessary ’shock therapy’?

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