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The Case for Money Finance:
An essentially political issue
Adair Turner
Chairman
Institute for New Economic Thinking
Institute of International and European Affairs Dublin, 26 April 2016
300 Park Avenue South - 5th Floor, New York, NY 10010 USA | 22 Park Street, W1J 2JB London, UK
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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
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Share of real estate lending in total bank
lending
Source: The Great Mortgaging, Professor Alan Taylor, University of California, Davis
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Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012
Source: IMF, Bank of Japan Flow of Funds Accounts
-15
-10
-5
0
5
10
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
PNFCs Government
%
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Japanese government and corporate debt:1990 – 2010
0
50
100
150
200
250
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Bank lending to non-financial corporates General Government debt
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
% G
DP
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Developed economies – Debt to GDP
70
90
110
130
150
170
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
Private Public
% G
DP
Source: Geneva Report No 16 Deleveraging, What Deleveraging? ICMB / CEPR September 2014
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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 Markets
Emerging Markets
World
% o
f G
DP
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Traditional policy levers blocked
First round stimulative effect
But concerns about long-term debt sustainability
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
Funded fiscal deficits
Ultra loose monetary policy• Interest rate at zero
bound
• QE
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Debt overhang : the unavoidable choice?
Sustained low growth and low inflation – debt burdens never
decline
Debt erosion via ultra low
interest rates
But leads to new debt creation
Debt write-off, default and
restructuring
But has disruptive / depressive
effect
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Out of ammunition ?
Central bankers are running down their arsenal. But other options exist to stimulate the economy
The Economist, 20th February 2016
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The case for monetisation
The price level should be controlled by“expanding and contracting issues of actualmoney…[and]… monetary rules should beimplemented and in turn should largelydetermine fiscal policy.”
Henry Simons (1936)
“Government expenditures would befinanced exclusively by tax revenues or thecreation of money.
… the chief function of the monetaryauthority [should be] the creation of moneyto meet government deficits and theretirement of money when the governmenthas a surplus.”
Milton Friedman (1948)
“A tax cut for households and businessesthat is explicitly coupled with incrementalBoJ purchases of government debt, so thatthe tax cut is in effect financed by moneycreation.. [with it clear that].. much or all ofthe increase in the money stock is viewed aspermanent”.
Ben Bernanke (2003)
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Monetary finance: increased fiscal deficit financed by permanent money creation
Central bank directly credits government current account
Government issues interest-bearing debt, which CB purchases and converts to non-interest bearing irredeemable “due from government”
Government issues interest-bearing debt, which CB purchases and perpetually rolls over
Option 1
Option 2
Option 3
Change in consolidated public sector balance sheet
A L
Non-interest bearing irredeemable money
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Four propositions
1
2
3
4
There exist circumstances in which appropriate to stimulate aggregate nominal demand
Monetary finance will always stimulate aggregate nominal demand
In some circumstances it will do so more certainly and with less adverse side effects than available alternative policies
The degree of stimulus can be controlled
√ ?
√√√
√√
√√
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Nominal GDP growth 2008 – 2015
2.9
2.4
1.0
-0.1
US
UK
EU
Japan
% per annum
Source: IMF WFO Database 2015, ECB statistical Data Warehouse
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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
Feb-16
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Policy tools and effects: the ‘Independence’ Hypothesis
Aggregate Nominal Demand
Prices
Real output Ultra loose
monetary policy
Debt financed deficits
Money financed deficits
Independence Hypothesis: Division of increase in nominal demand between prices and real outputis independent of the choice of policy tool used to stimulate nominaldemand.
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Proposition 2: Money finance will alwaysstimulate 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
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Proposition 2: Money finance will alwaysstimulate 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
Inadequate demand, deflation, low-flation are policy choices and neverunavoidable effects
Faced with inadequate nominal demand governments/central banks never run out of ammunition
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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
Quantitative Easing
Sustained negative
interest rates
Money financed deficits
Money financed deficits
Ability to change expectations through current words or actions is uncertain
Given uncertain/indirect transmission channels
Given potential harmful effects of excessive private leverage growth
More certain
than
Less adverse
side effects than
≥
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Proposition 4: The degree of stimulus can be managed
$10m
$10bn
$10tr
Degree of stimulus is proportional to the scale of the drop
… unless the “one of” promise is incredible
… and expectations of future further drop are induced
Case 1: In the simple imagined helicopter drop world • Money supply = monetary base
‘One-off’ drop of
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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
Ensuring that consolidated public sector has a
permanent non-interest bearing liability
Requires imposition of quantitative reserve requirements
Requires mandatory reserves to be non-interest bearing• Even if marginal reserves remunerated at positive policy rate
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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
Technical feasibility Political risksVS
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
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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)
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Containing political risks: a manageable challenge?
Possible regime Possible example
• Independent central bank pursuing inflation target, given authority to approve specific $bnof 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
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Japan: Two realities
Japanese government debt will never be repaid in the normal sense of the word ‘repay’
JGB’s bought by BoJ will never be sold back to the market
1
2
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Ensuring long-term Japan debt sustainability: IMF scenarios
Required cyclical changes in adjusted primary balance% of GDP
October 2015Fiscal Monitor
- 6.7 - 5.4 -3.2
• No sustainability scenario
• Forecast shows continued large deficit
by 2030
2010 2014 2020
Continuous surplus thereafter to reach
• 80% net debt• 200% gross debt
October 2014Fiscal Monitor
- 6.5 + 6.4
- 6.0 + 5.6
November 2010Fiscal Monitor
2015
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Eurozone outlook
Probability?
Federalisation, debt relief and monetisation/money financed fiscal stimulus
Significant economic recovery
Scenario 1
Continued negative interest rates and QE
Continued slow growth, below target inflation and rising political pressures
Scenario 2
Partial breakup within 5 years
Scenario 3
˂ 10%?
70%?
20%?
Break up at later date?