Central Banks and the King Midas touch…

One big lesson from the recent crisis should have been to ignore whatever econs and their inspired central banks have been telling us for some years now. Their role should have been marginalised. But the dependence on them and their wisdom has only risen.

We were told by celebrated econs that how central banks could have avoided great depression only if they eased their policy for an extended period of time. This became a wisdom of sorts and accepted at a wide scale. We could have only known the utility if this wisdom if there was another such crisis and had to wait for nearly eighty years for such an event to occur. And as the event struck, the ideas were implemented in frenzy. This was to ensure if Lords of Finance part II is written, it has just the opposite results. Alas we now know the limitations of this frenziness. It is all over the place.

In this spirit, it is interesting to read this speech by Kirsten Forbes of BoE. She invokes the lessons from King of Midas and how central banks behaved like one:

When the legendary King Midas initially received the power to turn everything he touched into gold, he deemed it highly successful; the benefits of being able to create immense wealth with simply the touch of his finger far outweighed any costs. During the financial crisis, many central banks used less glamorous tools to create base money – sharp reductions in interest rates and quantitative easing. These measures played a critically important role in helping economies stabilize and recover.

King Midas soon realized, however, that this power of wealth creation came with unexpected side effects – from making his food inedible to turning his daughter into a lifeless statue. As these costs accumulated, King Midas eventually wished to give up his “golden touch” and return to normality. Similarly, is the current UK policy of near-zero interest rates beginning to generate substantial costs? Is there a point where any costs accumulate such that they outweigh the benefits? Could near-zero interest rates become less “golden”?

And then we have a similar kind of story. What were cited as the benefits of low rates have become limitations as well.

But the Ms. Forbes story is incomplete. It is actually the case that central bankers behave like King Midas most of the time. They wash their hands but then quickly forget the lessons and become the king again. Whether rates are low or high, they try and behave like King Midas. The whole idea is to show that there is some magic to their actions and things will indeed turn into gold. They have a huge audience in the name of market players and media which keeps wishing for the magic. The monetary policies have become a huge magic show of kinds in the process.

In reality central banks are like those tailors which designed clothes for the king with economy being the king.  Only to realise the king had no clothes really. If the illusion works, they are called as magicians and all kinds of awards are honored.  As reality sicks in, the yesteryear heroes are discarded and new ones created. The game of illusion goes on.

As academicians, they keep warning us over the monetary illusion but there is a huge demand for being an illusionist. The aura and power of being the king is too tempting for anyone to ignore.

So the game shall continue…

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