Debt, Money and Mephistopheles: How do we get out of this mess? Adair Turner
Cass Business School 6 February 2013
Money finance as normal procedure: Friedman and Simons ‘Under the proposal, government expenditures would be financed entirely by tax revenues or the creation of money, that is, the issue of non-interest bearing securities… The chief function of the monetary authority [would be] the creation of money to meet government deficits and the retirement of money when the government has a surplus” Milton Friedman, A Monetary and Fiscal Framework for Economic Stability, America Economic Review, Vol 38, June 1948
“The powers of the government to inject purchasing power through expenditure and to withdraw it through taxation, i.e. the powers of expanding and contracting issues of actual money and other obligations more or less serviceable is money – are surely adequate to price level control. … in other words, the monetary rules should be implemented entirely by, and in turn should largely determine, fiscal policy.” Henry Simons, Rules and Authorities in Monetary Policy, The Journal of Political Economy, Vol 44, No. 1, February 1936
2
Helicopters and old bottles: Friedman and Keynes “Let us suppose that one day a helicopter flies over this community and drops an additional $1000 in bills from the sky, which is, of course, hastily collected by members of the community”
Milton Friedman, The Optimum Quantity of Money, Chapter 1, (1969)
“If the Treasury were to fill old bottles with bank notes, bury them at suitable depths in disused coal mines… and leave it to private enterprise on tried principles of laissez faire to dig the notes up again… there need be no more unemployment… and the real income of the country… would then become a good deal greater than it actually is.” John Maynard Keynes, The General Theory, Chapter 10, Section 6 (1936) 3
Levers and effects Fiscal policy: deficits or surpluses Monetary policy: - Interest rates - QE - Forward guidance Central Bank private credit support: - US “credit easing” - UK “FLS” Macro-Prudential Macro-Prudential policy: -policy: Bank capital and - Bank capital and liquidity liquidity standards
Prices
Aggregate Nominal Demand = Nominal GDP
Real output 4
Levers and effects O.P.M.F.
Fiscal policy: deficits or surpluses
Monetary policy: - Interest rates - QE - Forward guidance Central Bank private credit support: - US “credit easing” - UK “FLS” Macro-Prudential Macro-Prudential policy: -policy: Bank capital and - Bank capital and liquidity liquidity standards
Prices Aggregate Nominal Demand
Real output 5
Levers and effects
Aggregate Nominal Demand
Prices
Real output
Macro-Prudential policy: - Bank capital and liquidity standards
Division determined by • Spare capacity in labour or physical capital • Flexibility of price setting processes in labour or product markets 6
The “independence� assumption O.P.M.F.
Fiscal policy
Monetary policy
Prices
Aggregate Nominal Demand
Central Bank private credit support Macro-Prudential Macropolicy: Prudential - Bank capital and liquidity standards
Division of the effect between prices and real output is independent of the tools used to stimulate nominal demand
Real output 7
Possible contraventions of “independence� O.P.M.F.
Fiscal policy
Expect at ion c Sup p
Monetary policy
Central Bank private credit support MacroMacro-Prudential policy: Prudential - Bank capital and liquidity standards
ly e
nha
nc e
hannel?
Unconventional monetary policy or O.P.M.F. create expectations of future price effects?
me nt?
Aggregate Nominal Demand Supply enhancement?
Fiscal expenditure or credit support targeted to achieve supply increase as well as demand?
Prices
Real output
8
Friedman’s 1948 proposal: a simple illustration Suppose: Nominal GDP = 100 and money supply = 50 Sensible aim is to grow nominal GDP at 4% per annum, allowing for 2% real growth and 2% inflation Then: Equilibrium money supply growth might be around 4% Appropriate increase in money supply is achieved by running fiscal deficit of 2% of GDP, financed entirely by money Money supply grows by 2 (=4% for 50) 9
From fractional reserve to 100% reserve banking Fractional Reserve Banking Central Bank A
L Notes & Coins Reserves
Commercial Banks A
L
Reserves
Deposits
Loans
100% Reserve Banking Money supply
Central Bank A L Notes & Coins
Notes & coins & bank deposits
Deposit money = Multiple of reserves at central bank Total money supply = Multiple of base money
Reserves
Commercial Banks
Money supply
Notes & coins Reserves Deposits & bank Reserve deposits s
Deposit money = Reserves at central bank Total money supply = Base money 10
Laissez faire economics and the banking exception “in the very nature of the system, banks will flood the economy with money substitutes during booms and precipitate futile effects at general liquidation afterward” “private initiative has been allowed too much freedom in determining the character of our financial structure and in directing changes in the quantity of money and money substitutes.” Henry Simons, Rules versus Authority in Monetary Policy, Journal of Political Economy, Vol 44, February 1936. 11
Leverage in the real and financial sectors UK debt as a % GDP by borrower type (1987-2007), Debt Liabilities on B/S Corporate Household Financial
300%
USA debt as a % GDP by borrower type (1929-2007)
250% 200%
1987
Corporate Household
150%
2007
2002
1996
1990
1983
1977
1971
1965
1959
1953
1947
1941
1935
Financial 1929
Source: Oliver Wyman
100% 50% 10%
12
Private non-financial corporate deposits and loans: UK 1964 – 2009 40% 35%
Securitisations and loan transfers
Deposits
Loans
% of GDP
30% 25% 20% 15% 10% 5% 0% 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: Bank of England Tables A4.3, A4.1
13
Household deposits and loans: UK 1964 – 2009 100% 90%
Securitisations and loan transfers
Deposits
Loans
80%
% of GDP
70% 60% 50% 40% 30% 20% 10% 0% 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: Bank of England, Tables A4.3, A4.1
14
Private credit to GDP ratio and growth
Source: S. Cecchetti, BIS Working Paper No. 381 "Reassessing the impact of finance and growth"
15
Lending to UK business Percentage changes on a year earlier
50 40
All currency loans
30 20 10 0 -10 2012
2006
2000
1994
1988
1982
1976
1970
Source: Bank of England “Trends in Lending�
1964
-20 16
Lending to individuals Percentage changes on a year earlier
20
Unsecured Secured Individuals
15 10 5 0
2012
2010
2008
2006
2004
2002
2000
1998
1996
Source: Bank of England “Trends in Lending�
1994
-5 17
Japan-policy rate vs credit growth per annum 16 12 8
%
4 0 -4
Source: Datastream
Private credit growth (%pa)
Dec-11
Dec-09
Dec-07
Dec-05
Dec-03
Dec-01
Dec-99
Dec-97
Dec-95
Dec-93
Dec-91
Dec-89
Dec-87
Dec-85
-8
BoJ Policy rate 18
Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012 10 5 0 -5 -10
Source: IMF, Bank of Japan Flow of Funds Accounts
PNFCs
20 10
20 08
20 06
20 04
20 02
20 00
19 98
19 96
19 94
19 92
19 90
-15
Government 19
% GDP
Japanese government and corporate debt: 1990-2010
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
20
Shifting leverage: private and public debt-to-GDP 140
120
UK UK
120 100
80 % GDP
% GDP
US
100
80 60
60 40
40
20
20 0 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Household
Public
Source: ONS Note: PNFC = private, non-financial corporates; Public = central and local government
Household
PNFCs
160 140
Public
PNFCs
Source: BEA Note: PNFC = private, non-financial businesses; Public = federal, state and local government
Spain
120 % GDP
0 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011
100 80 60 40 20 0 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Household
Public
PNFCs
Source: ECB Note: PNFC = private, non-financial corporates; Public = central and local government
21
Alternative possible targets Price and real output / employment focused
Exclusively price focused Alternative inflation rate measures (e.g. excluding “one-ff” tax or commodity price effects
Blanchard et all
Higher inflation rate (permanently or for a period of time)
Circumstance contingent future guidance (loose policy till unemployment below x%)
Federal Reserve, Autumn 2012
Money GDP growth rate (as permanent rule or temporarily)
Guidance implying loose policy even after inflation rate back on target
Money GDP level trend
Price level trend Carney, December 2012
Woodford, August 2012 22
UK inflation: Bank of England forecasts and actual 6 5 4 3 2
Aug 09 Projection
Aug-10
Aug-11
Actual CPI
2013Q2
2013Q1
2012Q4
2012Q3
2012Q2
2012Q1
2011Q4
2011Q3
2011Q2
2011Q1
2010Q4
2010Q3
2010Q2
2010Q1
0
2009Q4
1 2009Q3
%
Inflation target
23
Public debt to GDP: US and UK National debt as % of GDP
300 250
% GDP
200 150 100 50 0 1930
Source: DMO, ONS
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
24
GDP Growth rates 1950 – 1970 Real annual average GDP growth %
Nominal annual average GDP growth %
US
US
UK
UK
Germany
Germany
France
France
Japan
Japan 0
2
4
6
8
10
12
14
16
0
2
4
6
8 % p.a.
10
12
14
16
Source: BEA (US), ONS (UK), FSO (DE), Cabinet Office (JP), Madison, FSA calculations
25
UK public debt deleveraging: 1945 – 1970 60
300
UK GDP
Public debt : GDP
250 200
Nominal value of UK public debt and GDP
40 £ bn
% GDP
UK public debt
50
150 100
30 20
50
10
Source: DMO, ONS 0
Source: DMO, ONS
0
1945
1950
1955
1960
10.0
1965
1970
1945
1950
1955
1960
1965
1970
UK inflation and nominal interest rates
9.0
Consumer price inflation
8.0
3 month treasury bill rate
7.0
%
6.0 5.0 4.0 3.0
Source: DMO Note: CPI is derived from RPI after 1947 and the national accounts consumption deflator before
2.0 1.0 0.0 1945
1950
1955
1960
1965
1970
26
Source: Central Banks -0 8
pr -0 8 Ju l-0 8 O ct -0 Ja 8 n0 A 9 pr -0 9 Ju l- 0 9 O ct -0 Ja 9 n1 A 0 pr -1 0 Ju l- 1 0 O ct -1 Ja 0 n1 A 1 pr -1 1 Ju l-1 1 O ct -1 Ja 1 n1 A 2 pr -1 2 Ju l- 1 2 O ct -1 Ja 2 n13
A
Ja n
Central Bank policy rates 6
European Central Bank
5
Bank of England
Bank of Japan
4
US Federal Reserve
3
2
1
0
27
Central Bank balance sheets as %GDP Japan Japan
EU
EU
UK
UK
US
US
28
Source: Bloomberg Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
%
Jan-91
Jan-90
Japan – 10 year nominal yield 9
8
7
6
5
4
3
2
1
0
29
UK trends in lending: % 12-month growth rates 20
(% 12-month growth rates)
15 10
%
5 0 -5 -10 2012Q4
2012Q3
2012Q2
2012Q1
Source: Trends in Lending, data as of 04/01/2013
2011
2010
2009
2008
2007
Lending to UK businesses Consumer credit
Secured lending to individuals 30
Gross lending to and repayments by UK nonfinancial businesses (ÂŁbn) SME gross lending
LB gross lending
SME repayments
LB repayments
60 50 40 30 20 10
Source: Bank of England, Trends in Lending, January 2013
2012 Q4
2012 Q2
2012 Q1
2011 Q4
2011 Q3
2011 Q2
0
31
Post-facto money finance: US 1940 to 1951 High powered base money
60
40 30
Source: Friedman and Schwarz, Monetary History of the United States
1955
1954
1953
1952
1951
1950
1949
1948
1947
1946
1945
1944
0
1943
10
No subsequent reversal / ‘exit’ 1942
20
Post-facto permanent money finance
1941
Federal Reserve commitment to keep interest rates at 2.5% buying bonds to achieve target
50
1940
Large wartime budget deficits ‘funded’ by government debt issues
32
Japanese Government debt as % of GDP Gross debt minus Government + social security holdings 30.6% of GDP Minus Bank of Japan
%
46% of GDP
Minus Japan Post 33.7% of GDP
Minus domestic commercial banks
Source: Bank of Japan, data as at end 2012, Japan Post Holdings accounts end March 2012
33
34
Varying actual and appropriate policies: McCulley and Pozsar’s framework Private Sector "M M"
Deleveraging Surpluses
Deficits
Leveraging Deficits
"Fat Inflation Tails" Crowding Out
Deflation Risks No Crowding Out
Inflation Risks "Crowding In"
"Fat Deflation Tails" Economic Depression
Surpluses
"B B" Austerity
Fiscal Policy
Stimulus
y
Unorthodox
Conventional Rates
"Z B"
x
QE
Monetary Policy
Source: McCulley and Pozsar
34
35
Private and public leverage cycles
Source: McCulley and Pozsar
35
36
Varying actual and appropriate policies: McCulley and Pozsar’s framework Private Sector "M M"
Deleveraging Surpluses
Unconv. Radical Nuclear
Rates "Z B" Monetary Independence
Source: McCulley and Pozsar
t n m M k c l o V s r v e R
h c r u t e s A n i a l P
Surpluses
Conventional
-
r t p o c i l e H
y e n o M
Deficits
Leveraging Deficits
"B B" Austerity
Fiscal Policy
Stimulus
y
x
QE ~
FMC
36
Two Policy options Option 1
Option 2
Several £100bns of QE with commitment to future reversal
Several £10bns of OMF of increased fiscal deficit (tax cuts or public spend increasing) … with commitment that this will be permanent
+ Funding for Lending
+ Relaxation of bank capital and liquidity standards Which will:
Be most effective in stimulating nominal demand? Have least adverse side-effects? 37
Fiscal adjustment required for long-term debt sustainability Actual today
Spain 69
Cyclical adjusted primary balance 2011 -5.1 -3.7
UK 82 US 103
-5.3 2.0
Net Debt
Italy 120 Japan 126
Cyclical adjusted primary surplus 2020-2030
-7.7
Required adjustment
5.5
+ 10.6
5.7
+ 9.4
7.5
+ 12.8
7.6
+ 5.6 12.6
To get to 60% debt to GDP by 2030
Gross Debt
Debt as % of GDP 2011
Required for debt sustainability
+ 20.3 To get to 80% debt to GDP
38
Money finance via Japanese banking system?
Commercial Banks Government
Government Current and bonds at close deposit to zero interest accounts at zero interest
Money claims of Japanese households & corporates
Close to money financing of deficits Closer still if government owns banks Which it does in case of Japan Post
39
Nominal GDP in four major economic areas: 2007 – 2011 115
Q1(Q1 2007 == 100 GDP 2007 100)
110 105 100 95
UK
US
Source: ONS, BEA, Eurostat, Cabinet Office (Japan)
EA
Q2 2011
Q1 2011
Q4 2010
Q3 2010
Q2 2010
Q1 2010
Q4 2009
Q3 2009
Q2 2009
Q1 2009
Q4 2008
Q3 2008
Q2 2008
Q1 2008
Q4 2007
Q3 2007
Q2 2007
85
Q1 2007
90
JPN
40
Developed economies’ GDP growth Q1 2007 = 100
Source: McCulley and Pozsar
41
Break-down of NGDP growth from trough (2009) to peak Δ Prices (GDP deflator)
Δ Nominal GDP UK: +10.4% US: +12.0% Eurozone: +7.1%
UK: +8.1% US: +5.2% Eurozone: +3.8%
Δ Real output UK: +2.2% US: +6.5% Eurozone: +3.1% 42
Breakdown of NGDP growth from trough: 2009 to 2012 UK
US
Eurozone
0%
20%
40%
60%
80%
Share of NGDP change due to prices Share of GDP change due to real output
100%
43
Faust (Part II) and OPMF: how bad was it? “Mephistopheles leaps to a single conclusion, that there has been too much deflation and austerity and what was lacking was money. There is, he says, plenty of gold and silver beneath the earth, and the Emperor simply needs to issue pieces of paper in the form of claims against the underground metallic treasure. The Emperor is suspicious of this clever advice. But everything in the empire improves as a consequence of the introduction of paper money. The generals are pleased because the soldiers are paid once more, the treasurer finds that he can pay off all the debts, tailors are busily making new clothes, ladies become more willing to embark on well paid romantic adventures, the property market booms.� Harold James, Germany should re-read Goethe’s Faust Part II, Financial News, October 2012 44