The Case for Money Finance: An essentially political issue Institute of International and European Affairs Dublin, 26 April 2016 Adair Turner Chairman Institute for New Economic Thinking 300 Park Avenue South - 5 th Floor, New York, NY 10010 USA 22 Park Street, W1J 2JB London, UK 0
Private domestic credit as a % of GDP: Advanced economies 1950 2011 Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013 1
Share of real estate lending in total bank lending Source: The Great Mortgaging, Professor Alan Taylor, University of California, Davis 2
Sectoral financial surpluses/deficits as % of GDP: Japan 1990 2012 10 5 0 % -5-10 -15 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 PNFCs Government Source: IMF, Bank of Japan Flow of Funds Accounts 3
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 % GDP Japanese government and corporate debt: 1990 2010 250 200 Bank lending to non-financial corporates General Government debt 150 100 50 0 Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations 4
2004 2005 2006 2007 2008 2009 2010 2011 2012 % GDP Developed economies Debt to GDP Private Public 170 150 130 110 90 70 Source: Geneva Report No 16 Deleveraging, What Deleveraging? ICMB / CEPR September 2014 5
% of GDP Global debt excluding financials 280 260 Emerging Markets Developed Markets World 240 220 200 180 160 140 120 100 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: Geneva Report No 16 Deleveraging, What Deleveraging? ICMB / CEPR September 2014 6
Traditional policy levers blocked Funded fiscal deficits First round stimulative effect But concerns about long-term debt sustainability Ultra loose monetary policy Interest rate at zero bound QE imperfect transmission to real economy investment and consumption Asset prices inequality Currency devaluation channel is zero sum game Only works by re-stimulating growth of private credit 7
Debt overhang : the unavoidable choice? Sustained low growth and low inflation debt burdens never decline Debt erosion via ultra low interest rates Debt write-off, default and restructuring But leads to new debt creation But has disruptive / depressive effect 8
Out of ammunition? Central bankers are running down their arsenal. But other options exist to stimulate the economy The Economist, 20 th February 2016 9
The case for monetisation The price level should be controlled by expanding and contracting issues of actual money [and] monetary rules should be implemented and in turn should largely determine fiscal policy. Henry Simons (1936) Government expenditures would be financed exclusively by tax revenues or the creation of money. the chief function of the monetary authority [should be] the creation of money to meet government deficits and the retirement of money when the government has a surplus. Milton Friedman (1948) A tax cut for households and businesses that is explicitly coupled with incremental BoJ purchases of government debt, so that the tax cut is in effect financed by money creation.. [with it clear that].. much or all of the increase in the money stock is viewed as permanent. Ben Bernanke (2003) 10
Monetary finance: increased fiscal deficit financed by permanent money creation Option 1 Option 2 Central bank directly credits government current account Government issues interestbearing debt, which CB purchases and converts to non-interest bearing irredeemable due from government Change in consolidated public sector balance sheet A L Non-interest bearing irredeemable money Option 3 Government issues interestbearing debt, which CB purchases and perpetually rolls over 11
Four propositions 1 2 There exist circumstances in which appropriate to stimulate aggregate nominal demand Monetary finance will always stimulate aggregate nominal demand? 3 In some circumstances it will do so more certainly and with less adverse side effects than available alternative policies 4 The degree of stimulus can be controlled 12
Nominal GDP growth 2008 2015 % per annum US 2.9 UK 2.4 EU 1.0 Japan -0.1 Source: IMF WFO Database 2015, ECB statistical Data Warehouse 13
Inflation in the Eurozone 2011 2015 2.70% 2.50% 1.40% 0.40% 0.20% -0.20% 2011 2012 2013 2014 2015 Feb-16 Source: Eurostat 14
Policy tools and effects: the Independence Hypothesis Money financed deficits Prices Debt financed deficits Aggregate Nominal Demand Ultra loose monetary policy Real output Independence Hypothesis: Division of increase in nominal demand between prices and real output is independent of the choice of policy tool used to stimulate nominal demand. 15
Proposition 2: Money finance will always stimulate nominal demand A direct fiscal stimulus but with no danger of Ricardian Equivalence offset An increase in household nominal net worth An asymmetric effect on private and public balance sheets Household gross nominal wealth increase No increase in NPV of public sector liabilities 16
Proposition 2: Money finance will always stimulate nominal demand A direct fiscal stimulus but with no danger of Ricardian Equivalence offset An increase in household nominal net worth Inadequate demand, deflation, low-flation are policy choices and never unavoidable effects An asymmetric effect on private and public balance sheets Household gross nominal wealth increase No increase in NPV of public sector liabilities Faced with inadequate nominal demand governments/central banks never run out of ammunition 17
Proposition 3: Monetary finance vs alternative policy options: impact on nominal demand Money financed deficits Debt financed deficits Same first round fiscal effect No possible Ricardian Equivalence offset Money financed deficits More certain than Forward guidance to influence expectations Ability to change expectations through current words or actions is uncertain Money financed deficits More certain than Quantitative Easing Given uncertain/indirect transmission channels Money financed deficits Less adverse side effects than Sustained negative interest rates Given potential harmful effects of excessive private leverage growth 18
Proposition 4: The degree of stimulus can be managed One-off drop of $10m Case 1: In the simple imagined helicopter drop world Money supply = monetary base Degree of stimulus is proportional to the scale of the drop $10bn unless the one of promise is incredible $10tr and expectations of future further drop are induced 19
Proposition 4: The degree of stimulus can be managed Case 2: In the real world of fractional reserve banks Money supply large multiple of monetary base Constraining future demand creation via banking multiplier Requires imposition of quantitative reserve requirements Ensuring that consolidated public sector has a permanent non-interest bearing liability Requires mandatory reserves to be non-interest bearing Even if marginal reserves remunerated at positive policy rate 20
Technical feasibility VS Political risks There are no valid technical reasons for excluding money finance from our policy toolkit Always stimulates nominal demand And technically possible to manage the degree of stimulus Great political risks that if taboo is broken, monetary finance will be used to excess Respectable argument: although MF is technically feasible and in some circumstances the best policy, we should exclude its use entirely in order to avoid political risks 21
Success of money creation in Pennsylvania was dependent upon the moderation with which it was used [whereas] the same expedient [ ] was [ ] deployed by several other American colonies but for want of this moderation [ ] produced [ ] much more disorder than conveniency. Adam Smith, The Wealth of the Nations (1776) 22
Containing political risks: a manageable challenge? Possible regime Possible example Independent central bank pursuing inflation target, given authority to approve specific $bn of monetary finance to ensure inflation in line with target Government decision on the precise use of additional fiscal resources Investment? One-off tax rebate? UK Monetary Policy Committee 2009 2012 375bn of temporary QE Or E.g. 37.5bn of additional fiscal stimulus financed with permanent money creation 23
Japan: Two realities 1 Japanese government debt will never be repaid in the normal sense of the word repay 2 JGB s bought by BoJ will never be sold back to the market 24
Ensuring long-term Japan debt sustainability: IMF scenarios Required cyclical changes in adjusted primary balance % of GDP 2010 2014 2015 2020 November 2010 Fiscal Monitor - 6.5 + 6.4 Continuous surplus thereafter to reach October 2014 Fiscal Monitor - 6.0 + 5.6 80% net debt 200% gross debt by 2030 October 2015 Fiscal Monitor - 6.7-5.4-3.2 No sustainability scenario Forecast shows continued large deficit 25
Eurozone outlook Scenario 1 Federalisation, debt relief and monetisation/money financed fiscal stimulus Significant economic recovery Probability? 10%? Scenario 2 Continued negative interest rates and QE Scenario 3 Continued slow growth, below target inflation and rising political pressures Partial breakup within 5 years 70%? 20%? Break up at later date? 26