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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

1

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

2

Share of real estate lending in total bank

lending

Source: The Great Mortgaging, Professor Alan Taylor, University of California, Davis

3

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

%

4

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

5

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

6

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

7

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

8

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

√ ?

√√√

√√

√√

13

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

14

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?