I have a doubt about monetary policy, as suggested by Walter Bagehot. He wrote a book "Lombard Street" in 1873, to comment on a recent banking crisis. There he recommends these measures to stop a banking panic:
- That the central bank lend freely.
- At a high rate of interest.
- On good banking securities.
The second point is particularly puzzling. In his own words:
First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.
This goes counter the main narrative in the press today, which is that central banks have to lower the interest rate in order to increase lending and economic activity, not to increase it. Bagehot's policies could actually exacerbate the crisis! A high interest rate might produce deflation, which exacerbates debts, like in the Great Depression. What is going on here?