Charles Goodhart: The State of the Global Economy - A Central Banker's Perspective

Welcome to our new video series called "New Economic Thinking." The series will feature dozens of conversations with leading economists on the most important issues facing economics and the global economy today.

This episode features Charles Goodhart, former member of the Bank of England's Monetary Policy Committee, who offers a central banker's view on the global economy. Below is an introduction from interviewer and Director of Institutional Partnerships Marshall Auerback. Watch the interview for more!

Why did central banks fail to see the crash coming in 2008?

In this wide-ranging interview, former member of the Bank of England’s Monetary Policy Committee Charles Goodhart offers a simple answer: “Everything that a central bank ought to be interested in was excluded from the model.”

He also explores the relative success of unconventional monetary policies – in particular quantitative easing – and the balance between fiscal and monetary policies, notably in Great Britain.  In contrast to some, Goodhart takes issue with the prevailing notion that the UK’s fiscal policy has been unduly restrictive, although he also suggests that critics of the government such as Robert Skidelsky have played a very useful political role in terms of preventing a wholehearted “austerian” takeover of economic policy in the UK.

On China, Goodhart argues that domestic monetary reform should precede international capital convertibility and a greater role for the renminbi. And on the euro zone, he is worried that the Cyprus example will lead to uncertainty about the handling of failing banks elsewhere.

While not a devout cheerleader for much of the financial deregulation that has taken place over the past 25-30 years, Goodhart cautions about throwing the baby out with the backwater, implying that the halcyon days of credit controls and comparatively limited access to housing finance (conditions that pertained in much of Europe during the early post-WWII period) were not a condition to which policy makers should aspire.

And as someone who spent many years working on the Bank of England’s Monetary Policy Committee in the late 1990s, Goodhart has some salutary advice for today’s central bankers and finance ministers, who tend to look for narrow, simple solutions to prevent a recurrence of crises of the sort that afflicted the global economy in 2008: whenever a government attempts to regulate any particular set of financial assets, these become unreliable as indicators of economic trends.

“Goodhart’s Law” is a useful reminder that as investors try to anticipate what the effect of the regulation will be, they invest so as to benefit from it, which in many ways is the story of the last decade. Goodhart first invoked this “law” in a 1975 paper, but it might even be more relevant today.

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Your readers may find the abstract below from an article:
The real financial crisis: an individual households' crisis
as available through MPRA No.48889 interesting:
"The real financial crisis in the U.S. and in other countries did not take place in the banking or the wider financial sector -yes banks and others financial institutions were affected by their own induced excessive lending schemes- but no, it seriously affected the individual households. More than 40% of the 53 million home owners who had a mortgage in the U.S. were affected by foreclosure proceedings over the period 2004-2012. Out of those 21.4 million households 5.4 million had their homes repossessed. Between 2006 and 2010 an additional 7.8 million Americans lost their jobs. Mainly as a result of the economic slowdown, between 2006 and to-day the U.S. government doubled its debts from $8.5 trillion till just below $17 trillion to-day. On top of this individual households lost $12.6 trillion in net worth in 2008, more than the total debt level on home mortgages in that year which stood at $10.5 trillion.

The focus of many economists is to find a general economic equilibrium and to study the relationship between money supply, inflation and economic growth levels. From above headline figures one can conclude that the U.S. economy was as far from a general equilibrium as one could possibly imagine. One may also conclude that it was not the money supply which changed dramatically (M2, seasonally adjusted, grew by 4.7% in 2003, 5.96% in 2004, 4.5% in 2005 and 5.76% in 2006), but rather the use of funds over the four years preceding 2008, which led to house price increases of over 30% in the three year period 2003-2005. It was the “abuse of funds” over the latter period which led to the subsequent losses in jobs, in incomes and net worth and in a reduction in economic growth rates which has lasted up till to-day. It was also one of the main causes of the growth in U.S. government debt over the last 7 years.

In this paper a “use of funds” theory will be developed, which will be based on actual economic developments, rather than on hypothetical links between money supply, inflation, and economic growth.

Emphasis will be placed on the two main long term borrowing levels which affect individual households: home mortgages and government debt levels. The borrowing behaviour of the company sector will not be a subject of discussion as a misallocation of funds to these companies will usually lead to bankruptcy, which means the company seizes to exist. Neither individual households nor a government disappear in the same manner.

Emphasis will also be placed on the costs of debt and the accumulation of savings in pension funds in this use of funds theory. It will be demonstrated that issuing (part of) government debt in an index linked manner is an ideal tool to lower the costs of funding for the three countries under consideration: the Netherlands, the U.S. and the U.K. Such funding will also act as an anti-cyclical instrument in times of slow or negative economic growth. The negative interest rate effects on fixed rate bond portfolios as a consequence of discontinuing quantitative easing can be counteracted by temporarily increasing the volume of index linked bonds.

The aim of this paper is to provide an insight into the links between lending activities, inflation, interest rates, economic growth and the ambition to provide for future incomes out of individual households own savings, rather than relying on a transfer system from those in work to those in retirement. "

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