30 March 2011

Reserves

Russ Roberts has a good post about how Japan's Ministry of Economy, Trade and Industry has been unable to impose top-down solutions to the fuel shortages in northern Honshu which are crippling the ability to get food and supplies in to refugees.

To summarize briefly, refineries are required to keep 70 days worth of fuel on hand for emergencies. But this limit was only lowered to 67 days in the wake of the disaster. A couple of weeks later it was lowered to 45 days.  The same sorts of top-down limits are in place for other resources, including at least use of main roadways, leading to other misallocations.

If this isn't an emergency that makes it necessary to use emergency supplies, I don't know what would be. It would be tasteless to say Godzilla, so... an alien attack?

This is, incidentally, exactly why I am not so sanguine about one of the most popular solutions for averting future financial crises, increased capital requirements. In order for them to work you must have a wise and benevolent enough regulator who can lower the requirements in during an emergency to the appropriate levels with the appropriate alacrity. Otherwise they do you as much good as the reserve fuel sitting in refinery tanks in Japan right now.

Perhaps an illustration is in order.

Imagine regularly wanting to buy a sandwich but not having any cash. So a rule is imposed: you must have $20 on you at all times. Next time you walk by the sandwhich shop you think, marvelous, I will spend some of the $20 in my wallet on a tasty lunch. But then you have only $15 left in your wallet, putting you afoul of the "capital requirement." So even with the new rule, you must have $25 in your pocket in order to get your sandwich. But if you couldn't keep yourself $5 over the minimum when the minimum was zero, why will you be able to stay $5 over the limit when the minimum is $20?

The number and complexity of various "emergency provisions" you need to make a system like this operate quickly takes reserve requirements from the realm of "obviously beneficial" to "potentially workable."  Either that, or you abandon rules for discretion and pray you have the right philosopher prince in charge when things go pear shaped.


Edited to add [3 Apr '11]David Henderson draws the same parallel I did, with an easier to state analogy.

No comments:

Post a Comment