Wednesday, February 15, 2012

What interest rates would central bank policy be set at if the Swedish model for dealing with bank solvency had been used?

A column in the Guardian observed that economists are dividing over the issue of which is better for an economy, UK austerity or US stimulus.

While that is an interesting topic, this choice of economic policies is the result of the choice policymakers continue to make between the Japanese model and the Swedish model for dealing with a bank solvency crisis.

Said slightly differently, what interest rate would central bank policy be set at if the Swedish model for dealing with a bank solvency crisis was implemented?

If the Swedish model were implemented, the real economy would be spared from further damage from both the losses on the excesses in the financial system and the distortion that hiding these losses under the Japanese model entails.

At the same time, banks would most likely show massive negative book capital after absorbing the losses hidden on and off their balance sheets.  Regular readers know, because this blog has documented the fact, that banks can continue to operate with massive negative book capital and still provide all the credit that the real economy needs to grow.

As a result, the question is if the Swedish model were implemented would we still have zero interest rate policies?

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