Status Updates From The New Lombard Street: How...

Decided to read this before tackling Capital Wars

In a money view perspective, if the Fed fails to raise interest rates in the face of a credit-fueled asset price bubble, the bubble will feed on itself, growing ever larger and having ever greater distorting effects, until it bursts. Concretely, if funding liquidity is too cheap, then market liquidity will be too cheap as well.

From the money view perspective, the most remarkable blind spot in the Taylor rule framework is the implication that interest rate policy should not take any notice of asset prices. The inherent instability of credit operates, after all, through a destabilizing feedback between expansion of credit and a rising market price of collateral.

From a money view perspective, the important question is how an interest rate policy guided by a Taylor rule feeds into the behavior of the dealer system, the central institution that translates funding liquidity into market liquidity.