The new Governor comes with a great deal of goodwill and cross party support. All want him to succeed. Success means using monetary and banking policy to promote faster and sustainable growth. Dangers include allowing a new asset bubble or two to overheat, and failing to do enough to spur the UK economy in the right direction. The latter is probably the bigger worry for more people.
The new Governor also has at his disposal a wide range of powers he can use and measures he can pursue. He is both the regulator of the commercial banks,and the fixer of the main short term interest rate. He can both advise on whether to buy in more government bonds and other instruments, and influence the balance sheets of all the main commercial banks in the system. He is both Chief Regulator and a major player in the financial markets.
The central anomaly in recent policy has been the divergence between the wish of the banking regulators, who want bank balance sheets to carry on contracting so banks have much more capital relative to their loans outstanding, and the Monetary policy Committee, who have wanted to increase the amount of money in circulation, which should mean expanding commercial bank balance sheets. Some Regulators now say they want banks to lend more whilst raising their capital ratios, or keeping a b igger reserve. In practice their requests to do this have not been implemented in the main, as banks have struggled to be profitable enough to justify more business, and do not think they can raise large amounts of new capital from the markets. RBS has reduced its balance sheet by £900 billion to try to improve its capital ratios. The government would not have been keen to put huge new sums into its share capital instead.
Most money today is not held as bank notes or gold coins, but held as deposits in commercial banks. It is deposit account and current account money that makes up most of the money supply and is what most of us and companies rely on to pay our bills and make any investments business can afford. If the authorities now want a faster expansion, they need to accept that more money will be held in bank accounts. The balance sheets of commercial banks will therefore exapnd, as your or my bank balance is the commercial banks’ liability.
They need to put our money to work. They need to lend a sensible amount of it on to make a profit. We will have stronger banks if they make a bit more money and keep some of the retained profit to strengthen their position and finance more loans. Demanding more capital and demanding more lending can be like trying to drive with your foot hard down on both the accelerator and the brake. The brake tends to win. How to have both stronger banks and finance a decent recovery remains the central policy conundrum. Sorting out RBS is central to resolving this issue. Moving on from treating the banks as the whipping boy for all the ills of society may also be necessary if we are to make faster progress.