CENTRAL BANKING AND MONETARY POLICY AFTER THE CRISIS
Adair TurnerSenior Fellow, Institute for New Economic Thinking
OMFIF City Lecture
10 December 2014
www.ineteconomics.org
300 Park Avenue South | New York, NY 10010
22 Park Street | London W1k 2JB
Recent central bank actions
Federal Reserve
2
Targeted reserve requirement reductions for lending to agriculture and small business
Bank of England
Purchase of MBS
FLS with “incentives for lending skewed towards SMEs”
Targeted LTRO: for non-mortgage bank lending ECB
PBOC
Bank of Korea Stimulus package: finance for SMEs
Private domestic credit as a % of GDP: Advanced economies 1950 – 2011
3
Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013
Debt contracts: The finance theory perspective
Non-state contingent contracts overcome “costly state verification” advantages over equity contracts in business finance
Essential to mobilisation of capital
Empirical evidence of benefits of financial deepening, i.e. bank credit ÷ GDP
4
Pre-crisis orthodoxy: monetary policy
5
Mervyn KingTwenty Years of Inflation Targeting,
The Stamp Memorial Lecture, 2012)
We assumed that we could ignore much of the details of the financial system Olivier Blanchard
Chief Economist of the IMF, October 2012
The dominant new Keynesian model of monetary economics
lacks an account of financial intermediation, so that money,
credit and banks play no meaningful role
Wicksell’s logic: I
Credit extended to entrepreneurs/businesses to fund capital investment
6
Marginal productivity of capital = Natural rate of interest
If Policy/Market rate < Natural rate Mal-investment and inflation
If Policy/Market rate = Natural rate Optimal investment and price stability
Wicksell’s logic: II
Natural rate is unobservable
7
But if Policy rate varied to ensure price stability
Then Policy/Market rate Natural rate ͠͠??
Inflation targeting objective Credit creation and leverage optimal if price stability achieved
Three conceptually distinct functions of lending
Finance of new capital investment
• Enabling inter-temporal shift of consumption within life time income
Finance of purchase of existing assets
Finance of increased consumption
• Non-real estate• Commercial real estate• Residential real estate• Human capital
• Real estate• Collectibles• Existing business assets – e.g. Leveraged
Buy Outs
8
Categories of bank lending: UK, 2009
9
227
1235
243
232 Primarily productive investment
Some productive investment and some leveraged asset play
Mainly purchase of existing assets
Pure life-cycle consumption smoothing
Other corporate
Commercial real estate
Residential mortgage (including securitizations
and loan transfers)
Unsecured personal
£bn
But also achieves life-cycle consumption smoothing
Share of real estate lending in total bank lending
10
Rat
io o
f re
al e
stat
e le
ndin
g t
o to
tal l
end
ing
18
80
18
84
18
88
18
92
18
96
19
00
19
04
19
08
19
12
19
16
19
20
19
24
19
28
19
32
19
36
19
40
19
44
19
48
19
52
19
56
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
20
04
20
08
20
12
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
10%
20%
30%
40%
50%
60%
70%
Source: The Great Mortgaging, Jordá, Schularick and Taylor, 2014
11
“With very few exceptions, the banks’ primary
business consisted of non- mortgage lending to
companies in 1928 and 1970. By 2007 banks in
most countries had turned primarily into real
estate lenders. The intermediation of
household savings for productive investment in
the business sector – the standard textbook
role of the financial sector – constitutes only a
minor share of the business of banking today.”
(Oscar Jordá, Moritz Schularick and Alan Taylor,
The Great Mortgaging, 2014)
Credit and asset price cycles: upswing
12
Expectation of future asset
price increases
Increased credit extended
Low credit losses: high bank profits• Confidence reinforced • Increased capital base
Increased asset prices
Increased lender supply of credit
Favourable assessments of
credit risk
Increased borrower
demand for credit
Credit and asset price cycles: downswing
13
Expectation of future asset price falls
Less credit extended
High credit losses: low bank profits• Confidence dented• Reduced capital base
Falling asset prices
Restricted lender supply of
credit
Cautious assessments of
credit risk
Reduced borrower
demand for credit
Credit extension and house prices
House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007
Source: BEA; ONS; ECB
0
20
40
60
80
100
120
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007%
G
DP
US UK Spain Ireland
0
50
100
150
200
250
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
Ind
ex:
20
00
= 1
00
Spain US UK Ireland
Source: Ministry of Housing (Spain), S&P (US), DCLG
14
15
Real estate a dominant risk in advanced economies – even without leverage Real economy debt overhang the crucial driver of post crisis recession – not just impaired financial system
Excessive credit growth may never result in excessive inflation
1700
1750
1810
1850
1880
1910
1920
1950
1970
1990
2010
0%
100%
200%
300%
400%
500%
600%
700%
800%Net foreign assetsOther domestic capitalHousingAgricultural land
Capital in Britain 1700 – 2010
16
% n
ation
al in
com
e
Source: Capital in the Twenty First Century, T. Piketty (2013)
Desirable urban land: a market without equilibrium?
17
Indeterminate price – is there
an equilibrium?
Potentially infinite supply of credit
and private money
Highly income elastic demand
Capital gains motivation
Expectations prices expectations
Inelastic supply of
locationally specific land
Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012
Source: IMF, Bank of Japan Flow of Funds Accounts
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-15
-10
-5
0
5
10
PNFCs Government
%
18
Japanese government and corporate debt:1990 – 2010
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
% G
DP
0
50
100
150
200
250
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20010
Bank lending to non-financial corporates General Government debt
18
Global debt excluding financials
Source: Geneva Report No 16 Deleveraging, What Deleveraging? ICMB / CEPR September 2014
100
120
140
160
180
200
220
240
260
280
01 02 03 04 05 06 07 08 09 10 11 12 13
Developed MarketsEmerging MarketsWorld
% o
f G
DP
21
Total German private sector leverage: 1991 - 2010
1991-Q1
1992-Q2
1993-Q3
1994-Q4
1996-Q1
1997-Q2
1998-Q3
1999-Q4
2001-Q1
2002-Q2
2003-Q3
2004-Q4
2006-Q1
2007-Q2
2008-Q3
2009-Q4
80
90
100
110
120
130
140
150
100
120
140
160
180
200
220
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
% of GDP
China: total social finance to GDP
22
% of GDP
Categories of credit creation and nominal demand
23
Stimulates nominal demandFinance of investment
Finance of consumption
Finance of existing asset purchase
Stimulates nominal demand but required just to offset impact of inequality ?
• No direct stimulus to nominal demand• Could just increase credit, money balances
and asset pricing• May stimulate demand via wealth effects and
Tobin’s Q effects• But not certainly proportional to credit
created
UK Credit, money and demand 2000 – 2007
Nominal GDP
Houshehold deposits
Mortgage credit
House prices
24
% change
105%
97%
79%
44%
Bank lending to real estate sector and prices: Japan 1981 – 1999
25
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%Commercial Land Price in
the Six Major Cities (L)
Bank Lending to the Real Estate Sector (R)
YoY%
Source: Japan Real Estate Institute; Bank of Japan; Profit Research Center Ltd; calculations by Prof. Richard Werner, Southampton University (see Princes of the Yen, Richard Werner, 2003)
Credit creation for GDP transactions and nominal GDP in Japan, 1983 – 1999
26
Source: Princes of the Yen, Richard Werner, 2003
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
-4
-2
0
2
4
6
8
10
12
-4
-2
0
2
4
6
8
10
12
YoY %
Cr (L)
Nominal GDP
YoY %
Explaining instability and secular stagnation | 27
Quantity theory of disaggregated credit*
NOT
But:
So that:
And:
∆M = ∆P. ∆Y
∆CR = ∆PR
∆CNR = ∆P. ∆Y
∆M = ∆CR + ∆CNR > ∆P. ∆Y
Velocity of circulation stable
… where CR = credit to finance real estate purchase+
PR = price of real estate
… CR = credit to finance GDP transactions P = prices of current goods and
services
Velocity of circulation falls
* See Richard Werner, New Paradigm in Macroeconomics
+ Or more generally to finance existing assets
28
Velocity of money circulation
Source: BoE, BoJ, Datastream
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
UK (M2) Japan (M2)
Velocity of Money (Nominal GDP/M4)
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
Japan (M4) UK (M4)
Velocity of Money (Nominal GDP/M2)
Monetary aggregates matter
But not because excessive Money is a forward indicator of inflation
But because excessive Credit is a forward indicator of crisis, debt overhang, post crisis depression and deflation
29
Not one objective, one instrument
30
Low and stable inflation insufficient
Credit and asset price cycle and rising leverage can produce macroeconomic instability while never producing excess inflation
• Interest rate elasticity of demand for credit varies by category
• Contrary to Wicksell, there is no one natural rate
Interest rate tool insufficient
31
Arbitrage helps policy
Gets into all the cracks
Advantage
Heterogeneity and instability of expected
returns and elasticity of response
Disadvantage
Interest rates as primary policy tool?
Other policy objectives and tools
32
• Constrain both pace of growth of credit
• … and the level of private sector leverage
• Offset bias in system toward real state lending
• Much higher bank capital requirements
• Much higher counter-cyclical capital requirements
• Increase capital risk weights for real estate lending above IRB levels
• Loan to income constraints on borrowers
• Banks with dedicated focus on non real estate
Objectives Tools
Recent central bank actions
Federal Reserve
33
Targeted reserve requirement reductions for lending to agriculture and small business
Bank of England
Purchase of MBS
FLS with “incentives for lending skewed towards SMEs”
Targeted LTRO: for non-mortgage bank lending ECB
PBOC
Bank of Korea Stimulus package: finance for SMEs