Tuesday, March 13, 2007

. Randall S. Kroszner: remarks on "Liquidity and Monetary Policy" to the U.S. Monetary Policy Forum, Washington, D.C.March 9, 2007

On March 5 Fed board governor Kevin Warsh gave a presentation on "Market Liquidity: Definitions and Implications". (See our review here). Now Randall S. Kroszner, another board member, discusses "Liquidity and Monetary Policy". This appears to be the critical issue at the moment. As Kroszner says: "A quick search of LexisNexis turned up 2,795 separate articles in the past six months alone that mentioned the word 'liquidity' in the context of its abundance in financial markets. The use of the term liquidity in these articles spans a wide variety of meanings--perhaps 2,795 of them! "

Unlike Warsh's piece, Kroszner's is a rather disappointing lecture on the role played by inflation expectations in the credit markets. Yes, lower inflation expectations lead to an increase in the supply of loanable funds and thus to lower long-term interest rates. We all know that. Mr. Kroszner then adds: "Explanations of these phenomena should have an international component". Fine: but where's the international component in his analysis? What is the role played by the dollar as the key international reserve currency? Why do foreign governments invest in such a massive scale in the US bond market? Is it all down to inflation expectations?

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