«We did a fairly good job in terms of the resilience of the financial system itself.»
The debt burden is enormous and deflation is persistent, therefore interest rates will remain low. This aggravates social inequality, which in turn fosters populism. This is the line of argument of Adair Turner, he is Chairman of the Institute for New Economic Thinking (INET), after having chaired the UK Financial Services Authority from 2008 to 2013, as well as the International Financial Stability Board’s (FSB) major policy committee.
Demand should be stimulated, says Turner, but not as hitherto with huge amounts of new central bank money to buy government bonds. More effective would be smaller amounts, with which the central bank finances government debt directly – this is referred to as helicopter money. Lord Turner gave a speech at the Fund Experts Forum of «Finanz und Wirtschaft».
Lord Turner, the danger of deflation seems to have vanished. Do we now have to brace ourselves for inflation?
Inflation has a heavy element of expectations. So of course it is possible, that inflationary expectations rise and that Inflation goes up. But my own feeling is that the deflationary forces in the world are still significant. Interest rates will remain low.
Is the expansive monetary policy not forceful enough to bring about inflation?
The monetary stimulus was massive. But what is amazing is the fact that all of that extraordinary strong monetary action has simply managed to get the inflation rate up from around zero closer to approaching target level at 2%. This suggests that there are some very fundamental structural factors going the other way.
Was a higher inflation to be expected?
If somebody had told you back in 2007 that we were going to have a deflationary problem, and that we were going to cut interest rates to zero and keep them there for eight years, and that we were going to increase central bank balance sheets to a quarter of GDP and do all this quantitative easing, what do you think the inflation rate will be? The answer would have been: 10%, or even 20%. This illustrates how deep the deflationary pressures are in the world.
Could more government expenditures help to overcome the deflationary forc-es?
Without the Chinese stimulus through the credit expansion of 2009 to today, the global economy would be in a much deeper deflationary trap. Last year, China has kept the stimulus going, which surprised me – I thought they would think that the domestic debt level had become unsustainable. But I don’t think that there is more of that to come.
What about fiscal policy in the USA and elsewhere?
There has been a significant fiscal relaxation around the Eurozone, and the UK government has basically abandoned its fiscal targets post Brexit – even if it still pretends that it’s on a path to a zero deficit. There has been a relaxation across the world and there is one anticipated in the US. All of that may produce a world in which we, for a period of years, return more to inflation in line with target and maybe an uptick in interest rates. But I still think there are deep deflationary factors.
Where will interest rates be heading for?
In the year 2020, the short term policy rates of central banks will still be close to zero in Japan, Switzerland and in the Eurozone. Policy rates in the UK may be ¾% or 1%, and in the US 2½%.
What about long term interest rates, which reflect inflation expectations?
What has happened over the last six month is that nominal rates have gone up, as expected inflation rates have increased. But long term real rates have really not gone up at all, there as low as before. Long term real rates will probably stay low, because they are not driven by expectations, nor by central bank policy, but by the structural balance between savings and investments in the world. That will continue to favour very low long term interest rates.
Ideally, higher interest rates would help to relieve pressure on banks and the financial system. Is there an imminent danger because of low rates?
I think the financial system is much safer than it was before the crisis. And I don’t think, hoping not to be overoptimistic, that we are going to see a rapidly developing financial crisis like we saw in 2008, because the banks have more capital, they have better liquidity, and we have reduced the risks in the derivative trading system. I spent five years as a financial regulator, also as chairman of the major policy committee of the Financial Stability Board, the FSB. And I was one of the hawks in that exercise, with my friend Philipp Hildebrand from Switzerland and with the Americans. We argued for high capital requirements. I think we did a fairly good job in terms of the resilience of the financial system itself.
So you can give the all-clear signal?
Our big problem is that there is so much debt in the real economy – companies and households and governments together. Therefore we find it very difficult to keep the economy going without creating more debt in a way which becomes a problem for the future. We end up almost trapped. In order to make this debt affordable, we need incredibly low interest rates.
Which is no problem, since interest rates will stay low anyway?
Low interest rates have some perverse effects. Part of the problem has been a secular rise in inequality. In such an environment, a strategy of keeping the global economy going by very low interest rates is bound to be good for those people who already have wealth. In contrast to lower income people, wealthier people tend to hold more of their wealth in marketable securities – in debt or equities. These go up, when the long term interest rate go down. Low rates have made some of our problems worse.
Inequality is also increasing because of technological change.
There is a systematic tendency, that attempting to keep the global economy going with very low interest rates will tend to further increase inequality of wealth. In an environment, where there are underlying technological drivers of increasing inequality, it is unfortunate to have a macroeconomic policy which, rather than leaning the other way, makes that more extreme.
What countermeasures could be taken?
After the financial crisis, stimulus has been later and accompanied with greater inequality and greater debt creation than was necessary. All of that has created political risks which have helped to give us Brexit and Trump and populism.
What should be done?
We have run large risks. The fiscal stance was too tight. So we hugely expanded the balance sheets of central banks in an attempt to stimulate the economy by pure monetary means. Much better than huge amounts of a pure monetary stimulus would have been smaller amounts of fiscal stimulus that is financed by the central bank.
You argue for so called helicopter money, printed by the central bank to finance government debt.
The Bank of England in 2009 did 400 Bio. £ of quantitative easing, QE, by buying bonds. And it says this will be reversed. It would have been better if the Bank of England had done 50 Bio. £ of monetary finance for an increased fiscal deficit, and telling the people that this was permanently monetary financed. The BoE would have ended up with a smaller central bank balance sheet and more stimulus to the economy. I believe that by forgoing fiscal stimulus with monetary finance, we have ended up with potentially dangerously high balance sheets.
What can be done regarding the large central bank balance sheets?
Let’s take the Japanese situation. There is no way that the Bank of Japan will ever sell back all their government bond holdings to the private sector – reversing QE. But it could sell back some of it.
A sale of government bonds could shake financial markets.
The Bank of Japan should tell the Japanese people that it has written off permanently for example a quarter of the government bonds that it holds. If that, along with a continued fiscal stimulus, increases the inflation rate back to 2%, then the Bank of Japan might sell its other holdings of government bonds back to the private sector. So the BoJ might shrink its balance sheet back to what it would have been, if in the first place, if it had done a smaller monetary financed operation, rather than a huge quantitative easing operation.
What happens with the quarter of the government bonds that the Bank of Japan has written off?
That is a permanently monetary financed operation, it’s an expansion of the money supply. The money supply will stay permanently higher. So far, with QE and the expansion of the money supply, the holdings of Japanese banks at the Bank of Japan have gone from 6% of GDP to close to 100% of GDP. I believe that a small amount of that permanent would have been better than a large amount temporary. But you can end up in the same place, if you now accept, that some of it is permanent – and some of it you reverse.
An increased money supply could eventually lead to high inflation.
Central banks always have tools to act. If you get back to a situation where inflation is too high, they have tools to reverse that. For example, they can sell bills to reduce money supply.
Many economists reject helicopter money, i.e. monetary-financed fiscal stimulus. They regard it as being too dangerous.
All of the difficult issues are not technical, they are political. The really legitimate argument against monetary finance, the one that I respect, is: If we break the taboo against it and tell politicians that it is possible, they will want to do it all the time in inappropriately large amounts, and in inappropriate circumstances – rather than only in small amounts in those specific circumstances where we’re short of nominal demand. I believe that there are circumstances in which monetary finance is either the only or the least risky way of stimulating demand.
Do you really think that politicians can be disciplined not to use the printing press?
Yes. The way Ben Bernanke suggested is as follows: The amount that you do should not be determined by the government, but by an independent central bank pursuing an inflation target. In a situation like 2010, where the inflation rate is too low and the central bank is trying to get demand up, and if the central bank thinks that its other tools are not going to work, it should be able to tell to the government: «In these circumstances, we propose that you should do a tax cut or a public expenditure increase, financed by central bank money.»
How would the central bank keep the government under control?
The central bank would print and put into an account for the government X Bio. $, but no more. The central bank controls the amount, the government controls how it is spent. And the central bank determines the amount, which in their judgement will help to get back up to inflation target but no more. That is essentially what Ben Bernanke argues for, and that is a way of using the tool of monetary finance, but in a completely disciplined fashion, rooted in an independent central bank, following an inflation target.
Should monetary finance pay for a new government deficit, or for existing government debt?
You can do both. If you haven’t done monetary finance, you can post facto do it as well. The Japanese, back in 2002 or so, should have run some deficits entirely financed with central bank money. And they should have done it year by year. But they didn’t. Instead, they ran very large deficits financed by the issue of debt. And then subsequently, but as an apparently separate exercise, the central bank bought that debt. Now, if the central bank holds that debt forever and returns the interest on that debt to the government, that will effectively be a post facto monetary finance.
In the debate among economists about monetary financing, is there some mutual understanding now?
I feel that there has been a big shift in the debate. My IMF paper argues that essentially this is technically possible but politically potentially dangerous. Nobody has given a successful critique, nobody has attempted a critique of it, which argues it out. I think the economics is clear, and I think it would have been optimal to use it. I fundamentally think that those of us who argue for it have won the argument.
Where should a government deficit be monetary financed nowadays?
We are now less likely to see it in the US, the UK and Europe, because the existing mix of policies has eventually produced a stimulus. It is very unfortunate, that we haven’t used the better tool but relied on those other ones – but they are eventually producing a stimulus that people say well ok, even if I’m now convinced that monetary finance is possible, it’s politically dangerous and we don’t need it. The focus of attention is rather on China and Italy.
Italy surely couldn’t do monetary financing within the Eurozone?
The Eurozone is a very particular structure. The difficulty is, that when you have a system with one central bank and multiple governments, this is a hugely more complicated thing to do. The issue is: Who is in charge of the fiscal stimulus. The danger in the Eurozone is, that if you do a bit of monetary finance, people would say: But hang on, once the Italians have realised it’s possible, they will lobby for it to occur again and again. And you either have the danger, that that is true. Or you have the fact that the Germans will believe that it is true and therefore will never allow it.
How can Italy reduce its debt burden?
I don’t think Italian government debt can be made permanently sustainable within the existing Eurozone structure without either a write-off, which would be much more disruptive than a Greek write-off, because Italy is much bigger, or some form of stimulus or subsidy beyond what is being done at the moment. The Eurozone is an incomplete monetary union with insufficient federal centralisation to make it a success.
Is China printing money for its budget deficit?
In an environment, where most of the banks are state owned banks, and most of the borrowers from the banks are either state owned enterprises or local governments, it is quite difficult to distinguish between a liquidity operation to support the banks, and what is quite close to a monetary financed fiscal operation. Suppose you have a local government which builds bridges and an airport and a six lane highway and a sports stadium and a museum, and it borrows money from a state owned bank which was lent money by the central bank at a low rate of interest. This is not pure monetary finance in the sense of the central bank printing money and giving it to the government. But in that sort of environment you get things which are substantively quite close to monetary finance, without being called monetary finance.
So in Japan, monetary finance is most advanced?
In Japan, it will be increasingly obvious, that de facto monetary finance is occurring. And increasingly, you will see private sector investment commentary which asks what the real level of Japanese government debt is, and starts knocking off some of the debt owned by the bank of Japan. There will be a sort of de facto acceptance of it. But even there, what may happen is that it de facto occurs without having to openly admit that it has occurred. That could be the model for elsewhere. You maintain the taboo, while breaking the taboo.