Inflation is low and collapsing, households have undertaken unprecedented deleveraging, low risk bonds pay little to nothing, equity premiums are very high.....on and on and on.As economists and politicians heap pressure on global central banks to continue, and even escalate, their unusually loose monetary policies in order to spur global demand, the fear that these measures could provoke another market convulsion is spreading.
“A major lesson of the last crisis is that accommodative monetary policy contributed to financial excesses,” said Lucas Papademos, a former vice president of the European Central Bank. “We are pursuing a similar policy for good reason. But there are limits — if you do this for too long, risks in the financial markets will materialize.”
And our best and brightest think monetary policy has been "unusually loose" and think our major concern right now is too much risk-taking because financial institutions are going farther and farther afield to bid up safe assets. I think everyone agrees that the 1970's was a period of loose monetary policy. What exactly is going on now, in terms of financial risk taking, that mimics the 1970's? If loose money is the key factor, this should be an easy question to answer.
We tend to think of interest rates and risk premiums in an additive fashion. We start with a risk free rate and add risk premiums to model risky assets. I wish we, instead, began with a benchmark required return for assets and then thought of the rate on debt as a discount from that required return. It looks to me like the market asset real required return has been fairly stable over time. If we looked at it this way, then we would now say, "Short term risk free bonds are paying an 8% discount in order to avoid exposure to manageable cash flow risk." It would be easier to think of increases in debt ownership as a flight from risk. High corporate profit levels are, in part, a product of a huge pool of risk averse savers saying, "Hey, if you're willing to take the residual risk, you keep the profits. Give me 1% a year, and leave me out of the rest of it." Since corporations tend to deleverage when debt rates are low (and are currently not very leveraged), some savings is drawn back into equity (because it is now less volatile) and into non-corporate debt.
This is why the tendency to demonize the financial industry seems so dangerous to me. Market prices contain a wealth of information, which we frequently misinterpret. (Why would we expect to always understand it?). We view investors as some sort of Frankenstein monster in a tux, and we demand that it be controlled by committees that can't tell the difference between loose and tight monetary policy.
Here is an educational video about the politics of finance and monetary policy.