Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.
It is not necessary, as suggested by Janet Yellen, to separate the central bank from the treasury in order to keep politicians’ hands off the printing press. Plus there’s a flaw in the “Yellen” or conventional way of keeping politicians away from the printing press: that “conventional way” gives power over stimulus to two arms of the state (central bank which does monetary policy and the treasury which does fiscal policy). That makes as much sense as a car with two steering wheels.
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Janet Yellen recently said, “In normal times I think it’s very important that there be a separation between monetary and fiscal policy and its primary reason for independence of the central bank…….. We have seen all too many examples of countries that end up with high or even hyper-inflation because those in charge of fiscal policy direct their central bank to help them finance it by printing money.”
Yellen is not of course saying anything unusual there. Indeed, it’s me that’s going to be the oddball and argue below that there’s something wrong with that passage and with the conventional wisdom. So here goes.
Under existing or conventional arrangements, central banks (CBs) have the right to adjust interest rates and do QE, while treasuries / politicians have the right to borrow money and spend it and/or cut taxes. “Borrow and spend” is widely regarded by economists as stimulatory, as is cutting interest rates.
But what’s the point of two arms of government having a say on stimulus? What if they disagree? That all makes as much sense as a car with two steering wheels driven by a husband and wife having a row.
Another anomaly.
A second anomaly in the existing system is this. It’s widely accepted that measuring inflation and deciding how much extra stimulus the economy can take next year is a very technical job. Certainly you won’t get a job on a CB committee that makes that sort of decision unless you have first class qualifications in economics and about twenty years’ experience as a professional economist. Of course those committees make mistakes, but it’s widely recognised that it’s better to have those committees made up of economists rather than plumbers and bricklayers.
But as against that, politicians (most of whom don’t even have the most basic qualifications in economics) are allowed a say in fiscal stimulus.
Why demand tip top qualifications for those implementing stimulus one way, but require so such qualifications for those implementing stimulus a different way?
Privately owned central banks.
A possible objection to the above “arm of the state” point is that some CBs are PRIVATELY owned. The answer to that is that ownership is simply a series of rights over something, and ownership is normally a pretty INCOMPLETE series of rights. For example I own my house, but that wouldn’t stop government compulsorily purchasing it and knocking it down to build a road.
Same goes for CBs, but even more so. For example while some CBs are nominally in private hands, those private hands have almost no rights. Reason is that the rules or customs governing the CB force the CB to act in the public interest, not in the interests of those private so called owners.
So the above description of a CB as an “arm of the state” is fair enough even when the CB is nominally in private hands (assuming the above rules and customs force the CB to act in the public interest.)
Summarizing.
To summarize so far, there two anomalies in having two arms of the state having a say on stimulus. First, that arrangement is like a car with two steering wheels. Indeed the latter arrangement contravenes the so called “Tinbergen principle”. Jan Tinbergen was an economics Nobel laureate and his principle stated roughly speaking that for each policy objective there should be one policy instrument and one only.
The second anomaly is that those working in one of the latter “arms” have to be highly qualified, while those working for the other arm need no qualifications.
So how can those anomalies be disposed of while still keeping politicians away from the printing press? Well it’s easy: just give OVERALL responsibility for stimulus (monetary AND fiscal) to the CB, while leaving clearly POLITICAL decisions with politicians. (To be more accurate, the body or committee that decides the TOTAL AMOUNT OF stimulus does not need to be based at the CB: the important thing is that it is kept at a distance from political influence.)
Now it might seem that separating the total amount of fiscal stimulus from POLITICAL decisions is near impossible: after all, if politicians decide for example to borrow more and spend it on say education, that is stimulatory plus it’s clearly a political decision. Certainly if more is spent on education, then all else equal, the proportion of GDP allocated to public spending rises, and that’s obviously a political decision.
In fact the latter “separation” can be achieved very easily and as follows.
The job of the CB should be to decide the TOTAL AMOUNT of extra spending or “aggregate demand” that is suitable during the next six months or year. And that includes private as well as public spending. As to politicians, they DO NOT have the power to spend more than they collect in tax because that is stimulatory. But they ARE FREE to raise or cut both taxes and public spending by the same amount.
So for example if politicians want to raise public spending by $X a year and raise taxes by $X to pay for that, they’re free to do so. They also have complete control over HOW that public money is allocated as between defence, education, road building, law enforcement and so on.
Central bank dominance.
It could be argued that the existing system is not so bad in that given an independent central bank, any excess stimulus deriving from those irresponsible politicians can be countered by interest rate increases imposed by the CB. But where that happens we get an artificially high rate of interest, and that does not make sense. Isn't it better to prevent excessive fiscal stimulus happening in the first place?
Conclusion.
The system advocated above under which the CB controls the AMOUNT OF stimulus, while politicians retain control of strictly political matters is an eminently logical division of labor.
Of course that all represents a HUGE CHANGE to the EXISTING split of responsibilities as between CBs and politicians. And certainly persuading politicians to relinquish their freedom to influence the total amount of stimulus (aka “mess up the economy”??) would be difficult.
Still, I think we should have the latter split of responsibilities as a long term goal.
And what do you know? That split of responsibilities is advocated by Positive Money, the New Economics Foundation and Prof Richard Werner here. The latter work actually advocates full reserve banking as well, but FR banking is not NECESSARILY an ingredient in the above new split of responsibilities.
Brexit means the UK re-arranges the way it trades with other countries. In particular, tariffs and non-tariff barriers are re-arranged.
Assuming extra tariffs imposed by the EU against UK exports is exactly matched by a REDUCTION in tariffs facing UK exports from other countries (and same goes for tariffs imposed by the UK against imports) then roughly speaking, there shouldn’t be an effect on Sterling when the dust has settled.
On the other hand, if raised tariffs by the EU exceed the effect of REDUCED tariffs by other countries, then the pound will fall in value.
But where would those increased tariffs erected by the EU actually get the EU? The answer is: “nowhere”. That is, as explained in the introductory economics text books, if country A erects tariffs against goods coming from country B, then BOTH COUNTRIES are likely to be hurt to the same extent. I.e. countries which impose tariffs against other countries shoot themselves in the foot.
People voted for Brexit for several reasons. One was the lack of democracy in EU institutions. Another was the fact that totally free and unrestricted movement of people for some strange reason is regarded as “sacrosanct” in the EU. That’s a problem because the EU has now lost control of its borders: Africans, Muslims etc are marching into the EU like an invading army. Plus it looks like there’s a good chance of Turkey joining the EU in the next five or ten years. In short, Brexit offers the chance of reducing the speed at which Britain becomes an Afro-Islamic state. (The fact that Islam is ten miles to the right of European “far right” parties, combined with the fact that the political left is positively in love with Islam is a self-contradiction that political left refuses to explain, far as I can see.)
So if the view of Brits is that they’d rather quit the EU because of the latter two and similar reasons, that’s not unreasonable. If the EU reacts by imposing relatively high tariffs against the UK, that is illogical behavior by the EU. It will result in a fall in Sterling. But that does not prove Brexit was a poor choice: you could equally well argue it proves the EU has gone into a sulk and decided to shoot itself (and the UK) in the foot. Plus those who attach a lot of weight to the above "democracy" and "Islam" point, may regard any cut in living standards that results from a Sterling devaluation as being a price worth paying for the benefits of more democracy and less Islam.
The above words of alleged wisdom from a Financial Times reader have gone viral on Twitter. “Wisdom” is an unduly flattering description of those words I think, but let’s examine them. (I’ve interspersed the passage – in green italics - with my comments)
“They have merely swapped one distant and unreachable elite for another.”
Wrong. Under rule from London, the supreme political authority, i.e. democratically elected politicians, can be voted out at the next election. That’s not true of the EU. MEPs can of course be voted out, but they don’t have much real political power. I.e. a large amount of political power rests with unelected bureaucrats.
As regards “distant”, a look at a map will confirm that London is about three times nearer the home of the average Brit than Brussels.
“Secondly, the younger generation has lost the right to live and work in 27 other countries.”
Wrong. People have simply lost the AUTOMATIC right to live and work in other countries.
“We will never know the full extent of the lost opportunities, friendships, marriages and experiences we will be denied.” So you live in a country with about 50 million people (the UK), where you can travel from one end of the country to the other very easily. Plus you can communicate at the speed of light with any of those people. And you don’t have an adequate choice of friendships and marriage partners? Complete BS. What must it have been like in the average village in the middle ages where people had a choice of about two marriage partners? Was everyone miserable because of that? If so, I don’t remember reading anything about that when I did history at school.
Moreover, after the Brexit process is complete, Brits will not stop visiting mainland Europe, nor will mainland Europeans stop coming to Britain for whatever reason.
Conclusion: lost friendships and marriages my arse, if you’ll forgive my French.
“Freedom of movement was taken away by our parents, uncles, and grandparents in a parting blow to a generation that was already drowning in the debts of our predecessors”. Wrong. I travelled round Europe before the EU existed. Passport checks at frontiers too about fifteen seconds.
"Thirdly and perhaps most significantly, we now live in a post-factual democracy. When the facts met the myths they were as useless as bullets bouncing off the bodies of aliens in a HG Wells novel. When Michael Gove said, ‘The British people are sick of experts,’ he was right. But can anybody tell me the last time a prevailing culture of anti-intellectualism has led to anything other than bigotry?” Well can you blame the plebs for taking a jaundiced view of those “professional economists”, “experts” and “intellectuals”?
First there were the plonkers who failed to regulate banks properly prior to 2007/8, which resulted in the bank crisis.
Second, the so called experts then spent far longer getting us out of the subsequent recession than we spent fighting WWII.
Third, at the height of the crisis two groups of so called experts the IMF and OECD were advocating consolidation / austerity: the exact opposite of what was needed.
Fourth, several economics professors at Harvard (e.g. Kenneth Rogoff and Carmen Reinhart) vigorously backed the above IMF/OECD call for austerity.
Fifth, there’s the small matter of catastrophic youth unemployment in Greece and Spain.
Of course the average pleb would not be able to reel off all the above examples of stupidity by “intellectuals”. But plebs probably WILL HAVE read about each of the latter five groups of plonkers at some point, and firmly fixed in the subconscious of the average pleb will be the impression that many self-styled intellectuals are nothing of the sort: many of them are actually pseudo intellectuals, charlatans and poseurs.
The plebs thus decided to rely largely on their own common sense, flawed as they would doubtless admit that to be.
They make the bizarre claim in their first paragraph that given a post Brexit recession, government would not be able to deal with it. Reason apparently is that: “With interest rates near zero and debt still high, the Bank of England and Government would have limited ability to prevent such a recession.”
Well the existing near zero rate may well preclude an interest rate cut. But that doesn’t rule out FISCAL stimulus. Ah, you might argue (as indeed the above 70 seem to suggest): but fiscal stimulus drives up the debt, and that’s already too high. But fiscal stimulus doesn’t have to be funded by debt: as Keynes pointed out in the 1930s, it can be funded by new money. Indeed, that’s exactly what we’ve done over the last three years or so: that is, we’ve implemented traditional fiscal stimulus (government borrows money, spends it and gives bonds to those it has borrowed from), and followed that by QE (central bank prints money and buys back the bonds). That all nets out to “the state prints money and spends it”, as suggested by Keynes.
So…have the above 70 economists actually studied economics? Have they heard of Keynes? Have they heard of QE?
The share of Britain’s exports going to the EU is declining, while the share going to the rest of the world is rising. If that trend continues, then in ten or twenty years’ time, Brits will be asking themselves with even more urgency: exactly what are we doing in the EU?
But the above chart UNDERESTIMATES the declining importance of the EU for Britain. Reason is that at the moment, British trade is clearly skewed TOWARDS the EU because of the tariff free agreements that Britain has with the EU. I.e. if Britain had the same agreements with the rest of the world, then the share of Britain’s exports going to those non-EU countries would be even higher.
Depositors want to engage in commercial activity, i.e. have their money loaned out so they can earn interest. But at the same time they want their money to be totally safe! Bit of a joke that, isn't it?
I mean any normal investor or lender knows perfectly well that they run a risk: at worst, they might lose everything. So what’s the excuse for a taxpayer backed safety net for depositors?
Well I’ll deal with that a few paragraphs hence. But first it’s important to qualify the latter claim that depositor insurance is taxpayer backed. That is, it could be argued that deposit insurance (at least in the US) is not taxpayer funded in that the FDIC is self-funding.
That’s a good point. On the other hand, the FDIC only covers small banks, not large ones. And in the recent crisis the larger banks were rescued thanks to a trillion dollar loan by the Fed at derisory rates of interest. (To be more accurate, the largest amount loaned by the Fed at any one time, according to this source, was about one trillion, whereas the AVERAGE amount loaned (over approximately an 18 month period) was about $600bn.)
As to exactly who was rescued by the Fed, it was not of course just retail depositors: it was a mixed bunch – bank shareholders, bond-holders, very large depositors and so on. In short, it’s not just small retail depositors who are featherbedded by deposit insurance, in the widest sense of the term “deposit insurance”: it’s a range of other bank creditors as well. I’ll use the phrase deposit insurance and the word depositor in that wide sense from now on.
A second weakness in the claim that the FDIC is self-funding is that it’s plain impossible for any private sector insurer to give a 100% guarantee that those insured will be rescued when a loss occurs (e.g. when your house burns down or your car is stolen). Reason is that private sector insurers sometimes go bust. In contrast, everyone knows the FDIC, and similar deposit insurance systems in other countries, are backed by an almost limitless source of money: the taxpayer. And that ability of government to rob taxpayers in the event of the FDIC not being able to meet claims is not a free market transaction: it’s a subsidy of the FDIC.
To summarize, while deposit insurance is TO SOME EXTENT self-funding, it is not entirely self-funding: i.e. it relies partially in taxpayers.
The justification for deposit insurance.
Let’s now return to the question posed at the outset above, namely: “What’s the excuse for a taxpayer backed safety net for depositors?”
A common excuse is that the arrangement encourages lending and investment. Indeed that excuse was given by the UK’s “Independent Commission on Banking” (sections 3.20-3.24). Well there are a couple of problems there.
First, if taxpayer protected deposits at banks and hence bank lending is encouraged, that clearly increases lending, but it also increases debts. And in fact the world is awash with people (e.g. the UK’s former business secretary Vince Cable) who advocate more bank lending in one breath, and then deplore the recent growth in debt in the next breath.
Second, if a taxpayer funded safety net for depositors does in fact encourage investment, then exactly the same applies to ALL FORMS of lending, for example bonds issued by corporations and cities. Come to that, why not take it even further and have a taxpayer funded safety net for SHAREHOLDERS?
In short, there’s a big anomaly at the heart of deposit insurance which is this. If you buy bonds in corporation X there’s no taxpayer protection for you. But if you deposit money at a bank which in turn lends your money to corporation X, then you’re protected. I.e. deposit insurance is simply an artificial form of assistance for a collection of middle-men known as “banks”.
Is lending stimulatory?
Another apparent excuse for artificial encouragement for lending is that a rising level of lending / debt is stimulatory: it increases aggregate demand. Indeed Steve Keen produced a good video explaining that point. (I suggest starting at 12.45).
Well a rising amount of lending / debt is indeed stimulatory, as Keen explains. But first, debt is dangerous, especially when there is too much of it. As Keen explains, when a debt bubble deflates, the entire economy deflates, all else equal.
Second, if we have $Y less demand stemming from a rising level of debt, it’s the easiest thing in the world for any government with its head screwed on to implement $Y of stimulus so as to counteract the reduced demand stemming from debt.
To summarize, the idea that lending and debt are beneficial in that they can boost demand is not a brilliant argument.
So what’s the solution?
So how do we ensure that people have a totally safe way of storing surplus cash without the taxpayer being on the hook? Well the authorities in the US have recently solved that problem, at least in the case of the money market mutual funds (MMMFs).
MMMFs will shortly come in two varieties. First, where an MMMF promises depositors they’ll get 100 cents back for every dollar deposited, that money can only be lodged in a totally safe fashion: at the Fed or the money can be put into short term government debt.
Second, where MMMF depositors want their money put into something more risky (something which will doubtless earn more interest, like corporate bonds), then the relevant MMMF cannot make the latter “guaranteed to get your money back” promise. That is, depositors who want the latter more risky option will see the value of their stake in the MMMF float, as is the case with mutual funds which invest in a wide selection of corporate shares (unlike MMMFs which concentrate on relatively safe corporate bonds).
So MMMFs can’t fail!
MMMFs are banks of a sort. But soon they will be banks which cannot fail.
Certainly the above safe MMMFs can’t fail. And as to the riskier MMMFs / “banks”, if they make silly loans, all that happens is that the value of depositors’ stakes in relevant MMMFs falls: the MMMF cannot go insolvent. What more do you want?
That principle should be applied to ALL BANKS. That would make banks fail safe. Plus it would put an end to taxpayer subsidies for banks and depositors.
In 2008, Barclays came up with a great idea for improving its capital ratio: create a few billion pounds out of thin air and lend it to an Arab sheikh (Sheikh Mansour) on condition he used the money to buy newly issued shares in the bank.
According to a Science Direct paper by Prof Richard Werner entitled “How do banks create money…”, that trick was illegal, “But regulators were willing to overlook this”, as Werner put it. And apparently the justification for that illegality was (to quote Werner again) that “This certainly was cheaper for the UK tax payer than using tax money.” OK, let’s run thru this.
In the recent recession, stimulus was needed, plus it was clear that banks needed to be made safer, e.g. by increasing their capital ratios. But there is a possible conflict there.
If increasing bank capital ratios (as per the Modigliani Miller theory) has no effect on the cost of funding banks, then there isn't too much of a problem. That is, banks can simply be ordered to raise their capital ratios, plus stimulus can be implemented.
That stimulus does not cost taxpayers anything. Reason is, to over simplify a bit, that in the case of helicopter drops (one form of stimulus), the state simply prints money and spends it (and/or cuts taxes). There is no need to rob taxpayers of a single penny. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”
Of course stimulus can take various forms other than helicopter money (HM), but actually fiscal and monetary stimulus combined come to much the same thing as HM, as others have pointed out. That is, under traditional fiscal stimulus, government borrows £X and spends it and/or cuts taxes, and it gives £X of bonds to those it has borrowed from. The central bank then prints money and buys back at least some of those bonds so as to make sure interest rates don’t rise. Or maybe the central bank prints money and buys back ALL OF those bonds, which is pretty much what has happened under QE in recent years. The latter scenario nets out to the same thing as HM.
So let’s assume that stimulus takes the form of HM (a policy which is actually advocated by some, e.g. this lot)
What if Modigliani Miller is not valid?
An alternative possibility is that MM is NOT VALID, i.e. that increased bank capital ratios do in fact raise bank funding costs. In that case, raising those ratios will indeed cut lending which will be deflationary, but that deflationary effect is easily countered with more HM. So again, there is no cost to the taxpayer, and thus no excuse for dodgy loans to sheiks.
Yet another possibility is that MM is not valid, but government is determined not to let lending by banks decline. That of course is a totally illogical stance: after all if the cost of funding banks (or growing apples) rises, then it’s reasonable to expect a fall in bank lending (or apple sales). Indeed, it was blindingly obvious in 2008 that banks had over-extended themselves, i.e. loaned out too much, thus a CONTRACTION in total bank lending would have made very good sense.
As to what REASON government might have for insisting that bank lending should not fall, the possibilities aren’t too hard to fathom. One is that politicians are beholden to bankster / criminals for funding political parties. Another is that because bankers wear smart suits, drive smart cars and have nice houses in the country, politicians conclude that bankers must know what they’re talking about. Thus when bankers say banks cannot be allowed to shrink, else civilisation as we know it will come to an end, politicians jump to attention and do what bankers want.
Taxpayers subsidize banks.
Yet another possibility is that MM is not valid, government is determined not to let the size of the bank industry shrink, and decides to deal with that by some sort of taxpayer funded subsidy for the process of increasing bank capital. That’s the ONLY circumstance in which the “Sheikh Mansour” trick would save taxpayers’ money. But for reasons given above, refusing to let the size of the bank industry shrink makes no sense whatever.
Conclusion.
This is nonsense from start to finish, unless I’ve missed something.
I nearly always agree with Lars, but not with this criticism he makes of NAIRU. Basically he just plays the old straw man trick: he attributes a characteristic to NAIRU which just isn’t there in dictionary or text book definitions of the concept.
To be more exact he claims NAIRU is a “timeless long-run equilibrium”. Well NO IT’S NOT!! That is, advocates of the NAIRU concept make it perfectly clear that the level of unemployment at which inflation rises too much or “accelerates” can vary with a whole host of factors: changing skill levels of the workforce, changing patterns of supply and demand which will make some skills obsolete, and so on.
And in case you’re wondering why I haven’t left the above two paragraphs on his blog in the form of a comment, reason is that his blog is powered by Wordpress which I’ve found over the last few years to be a constant pain in whatsit. Leaving comments on his blog seems to be impossible.
Narayana Kocherlakota, a professor of economics at the University of Rochester and he served as president of the Federal Reserve Bank of Minneapolis from 2009 through 2015.
In this Bloomberg article he argues for 2% inflation because 2% has always been the target, and we should stick to it so as to provide PREDICTABILITY for everyone: investors, savers and so on. However, that predictability point doesn’t tell us what the FUNDAMENTAL arguments for 2% are (as opposed to 0%, minus 3% or any other figure).
One fundamental argument for a small positive rate stems from the “wages are sticky downwards” point. That is, it’s desirable for wages in different professions to change relative to each other in line with supply and demand. But it’s difficult and sometimes impossible to actually cut wages in some sectors, else you get strikes. Ergo to some extent RELATIVE wage changes have to come about raising the wage in some sectors, rather than by cutting them in others.
Also inflation is a tax on people and firms with piles of cash and no idea what to do with it. Taxes have to be collected, and that tax on hoarders isn't a bad tax.
I argued yesterday that it’s OK for a bank to lend to someone on condition they purchase shares in the bank.
Having slept on the problem (which included a nightmare involving me buying favors off politicians on behalf of Goldman Sachs, ha ha) I’ve changed my mind. It now strikes that fake capital is not actually acceptable. Moreover, what’s wrong with it is the same as what’s wrong with the ENTIRE commercial bank system, namely that commercial / private banks have the right to print some of the money they lend out. That right amounts to a subsidy of private banks in exactly the same way as backstreet counterfeiters are effectively subsidised by the community at large. Indeed that’s what I argue in this paper (which with a few modifications is appearing in an economics journal shortly).
The standard bank “loans create deposits” trick, which is how banks create or print money is obviously not EXACTLY the same as the fake capital trick, but the flaw in both those tricks is the same. I’ll explain.
If a bank out-competes non-bank entities for shareholder funds, e.g. by offering a better return on capital, that’s a fair free market contest which the bank wins. But if the bank obtains funds by simply printing money and lending it to someone at an artificially low rate of interest, and that someone buys shares in the bank, that is not a genuine free market contest between the bank and non-bank firms: the bank obtains shareholder funds on a subsidised basis. Ergo the fake bank capital trick is unacceptable. But so too is the entire private bank system in its present form (sometimes referred to as “fractional reserve” banking).
Incidentally, the sort of people who are going to borrow from a bank with a view to buying the bank’s shares will tend to be people who don’t have much to lose should they go bankrupt: they will tend to be people with no net assets, far as I can see. I.e. if person X initially has no net assets and they borrow $Y and buy $Y of shares and the shares become worthless, then X is bust. But X had no net assets to start with, so X doesn’t lose much. On the other hand, there’s a chance the bank shares do well, in which case X cleans up. So for the Xs of this world, it’s a “heads I win, tails I don’t lose” bet. X might as well go for it.
Having said that, when Barclays printed a few billion and loaned it to Sheikh Mansour on condition he bought shares in Barclays, I assume Mansour WOULD HAVE lost out, had Barclays’s shares declined, because presumably Mansour had ample net assets. As it turned out, Mansour subsequently sold the shares and made £2.25bn profit.
But to reflect that risk, Mansour would have demanded some sort of perk from Barclays, and seems he did, and got it, to judge by Vincent Richardson’s comment after yesterday’s post on this blog. (BTW Vincent, like me, is an active Positive Money supporter in the North East of England).
And finally, assuming my above argument is correct, then defenders of the existing private bank system are in a bit of a jam: if they want to object to fake bank capital, they’ll have to admit that the entire private bank system is flawed.
Spanish banks have started copying the Barclays fake bank capital trick, i.e. creating money out of thin air and lending it to whoever on condition they buy shares in the bank.
Far as I can see (which may not be very far), this doesn’t matter too much. To illustrate…
Say a bank has the sort of capital ratio advocated by Martin Wolf and Anat Admati, i.e. say 25%, and say that’s all “fake” capital – in the Barclays / Spanish sense. Say the value of the bank’s assets fall by 25%. The bank won’t be insolvent. That’s an improvement on the situation where the bank has a capital ratio of say 5% all of which is “genuine capital”, and assets fall in value by 25%. In the latter scenario, the bank IS INSOLVENT.
(If the above link doesn't work, Google title of the article, i.e. "Next Banking Scandal Explodes in Spain" published by "Wolf Street".)
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P.S. (10th June 2016). I’ve changed my mind on this issue. See next day’s post.
I normally agree with Robert Skidelsky, but he goes a bit off the rails in this article where he initially attacks helicoptering, before concluding that it’s not such a bad idea.
By way of attacking helicoptering he quotes a not too brilliant passage from Keynes, as follows.
“For whilst an increase in the quantity of money may be expected…to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money.”
Now that’s like saying that turning up the central heating won’t make the house warmer if at the same time someone opens all the windows and doors. Or to put it in more general terms, when it’s claimed that A and B are positively related and that cause / effect runs from A to B, the normal or common sense assumption is that increasing A will increase B. Of course, implicit in that common sense argument is the very reasonable “all else equal” assumption.
To put it less politely, if I said that turning up the central heating makes the house warmer, and someone responded by saying “not if someone opens all the doors and windows”, I’d tell that someone exactly what to do with himself.
Moreover, even if someone DOES open all the doors and windows, if the central heating emits ENOUGH HEAT, the house will get warmer DESPITE the doors and windows being open.
Likewise, even if the public’s liquidity preference DOES INCREASE a bit, a big enough money supply increase will outweigh the latter effect.
Next comes this passage in Skidelsky’s article:
“Economists are now busy devising new feats of monetary wizardry for when the latest policy fails: taxing cash holdings, or even abolishing cash altogether; or, at the other extreme, showering the population with “helicopter drops” of freshly printed money.
The truth, however, is that the only way to ensure that “new money” is put into circulation is to have the government spend it. The government would borrow the money directly from the central bank and use it to build houses, renew transport systems, invest in energy-saving technologies, and so forth.”
Now there are a few problems with that passage. First, whence the assumption that the only way to “ensure that new money is put into circulation is to have government spend it”? That is, if government does “shower the population” with “freshly printed money”, why would that money not then be “in circulation”? I mean does the average lottery winner on receipt of their new found pile of cash bury it underground or just leave it all in a bank term account?
Clearly not! They SPEND a significant proportion of that cash: i.e. put it into “circulation”.
Second, the passage from Skidelsky’s article quoted above actually contains an element of POLITICAL bias, which is not something a professional economist ought to do. That is, in advocating more public spending, Skidelsky is adopting a left of centre stance. But the government of the day might be right of centre and might be aiming to CUT public spending, in which case, given a need for stimulus, that government would aim to increase PRIVATE spending rather than PUBLIC spending. Such a government could get more money into “circulation” by cutting taxes or raising social security benefits (the former being more right of centre than the latter of course).
In short, instead of advocating more public spending, Skidelsky ought to have used a politically neutral phrase like “raise the deficit” or similar.
Of course it may be that we get a better so called “bang per buck” from public spending as compared to tax cuts, but that is irrelevant, and for two reasons. First, the democratic choice of the population takes precedence over minor technical matters like bang per buck: that is if voters want more (or less) public spending, government should comply with voters’ wishes.
Second, the entire bang per buck concept is irrelevant. Reason is thus. Advocates of the bang per buck idea view money at government’s disposal as some sort of REAL COST. It isn't: government (assisted by the central bank) can create infinite amounts of new money at the press of a computer mouse, and at NO COST.
Thus if the average household has to be supplied with rather a large amount of cash to induce it to up its weekly spending, what of it? The cost of supplying that cash is zero. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.” (Ch3 of his book “A Program for Monetary Stability”).
(BTW: hat tip to Mike Norman for drawing my attention to the Skidelsky article.)
Terzi sets out some ideas on helicoptering in this article. I’ve reproduced the article below with my comments interspersed (in green italics).
In his piece on helicopter money, Lord Adair Turner seemed to argue that:
1) The money multiplier provides the needed boost to expansionary fiscal policy, yet this boost could generate inflation.
2) The risk of inflation could be managed by raising reserve requirements as needed.
Both statements are incorrect. So why exactly would raising reserve requirements not succeed in raising interest rates? An explanation is needed. After all, it’s widely accepted that central banks can keep interest rates up PRECISELY by keeping commercial banks short of reserves.
And this is the slightly expanded version of my Letter to the Financial Times (FT.COM published an abridged version)
In ‘The helicopter money drop demands balance’ (May 22), Lord Adair Turner defends the notion that bigger fiscal deficits are needed to end the current stagnation, but leaves one question unanswered: Why should a money-financed deficit be more powerful than a traditional debt-financed deficit?
...Because money (base money to be exact) is a bit more liquid than government debt!
Money-financed fiscal deficit is one particular form of government spending (in excess of taxes) that is funded by the central bank directly crediting the recipient banks with central bank money. In a traditional debt-financed fiscal deficit, banks are ultimately credited with government securities.
No. In a “traditional debt-financed fiscal deficit”, the entities “credited with government securities” are (surprise, surprise) those which buy those securities, which for the most part are not commercial banks. In fact commercial banks in the US and UK hold only 5% (very roughly) of government debt. The vast majority is held by pension funds, insurance companies, foreigners, you name it.
The expansionary effect of the two options must then be equivalent, as private sector’s disposable income increases by precisely the same amount, the only difference being that banks hold a bigger balance with the central bank in one case and a bigger credit balance with the government in the other case.
Yes, obviously the INITIAL expansionary effect is the same, but there are SECONDARY effects, like the above mentioned liquidity difference.
Indeed, large-scale purchases of government debt by central banks (a.k.a. QE) are a form of ‘helicopter money’ for a given fiscal stance, as they substitute central bank money for government debt, and their dismal results are evidence that funding public debt with central bank money provides no special boost.
To say there is “no special boost” is going too far. QE does have a FINITE effect, but clearly not a big one.
The belief that an increase in bank reserves would boost an expansion of bank credit has been convincingly refuted by all central banks’ experts on monetary operations. The money multiplier is inapplicable to a floating currency, and the only reason for having reserve requirements is to limit the volatility of money market rates under current liquidity management arrangements.
Turner recommends helicopter money as a way to manage fiscal deficits without creating more public debt. However, central bank money is another form of debt, and any narrative that begins by assuming that government debt is bad won’t go very far by proposing an increase of debt in a different form.
“Central bank money is another form of debt”? Well it’s a strange form of debt. Reason is that government has the right to grab any amount of money it wants off the private sector via taxation. That’s the equivalent of me having the right to break into the bank that granted me my mortgage and grab wads of £10 notes with a view to paying down my debt to the bank. You can call that a debt owed by me to the bank, but like I say, it would a strange sort of debt.
Also, who says “government debt is bad”? One of the basic bits of logic behind money financed deficits is that the lower is interest on government debt, the nearer do base money and government debt become the same thing (as pointed out by Martin Wolf). Thus if an economy in need of stimulus continues to refuse to react to interest rate cuts, there must come a point at which debt financed deficits become pointless and one is FORCED to switch to money financed deficits. Strictly speaking that point is when interest on government debt is zero, but clearly when interest on the debt is say 0.1% there probably won’t be any takers. So one might as well make the switch when the rate is 0.5% or so.
A better version of Turner’s important point that fiscal deficits are needed is to question current debt limits. Designed to check governments’ spending power, they have caused collateral damage by leaving the support of growth entirely to private debt. And private debt is critically pro-cyclical.
And finally there is something fundamentally illogical about debt financed deficits, which is that the basic objective is STIMULUS, but borrowing is “anti-stimulatory”: that is, it has a DEFLATIONARY effect. So debt financed deficits are a bit like chucking dirt over your car before washing it.
Moreover, debt is attractive to foreigners, for example China, Japan, etc hold a large stock of US government debt. I don’t see anything desperately clever about getting into debt to foreigners, not that doing so is necessarily a disaster.
