Sunday, 24 February 2013

Helicoptering does not damage central bank independence.



Stephen Grenville, visiting fellow at the Lowy Institute for International Policy, gives us the benefit of his views on Adair Turner type overt monetary funding of deficits. That’s in this Vox article. (h/t to MikeNorman).
It would have been nice if Grenville had studied the literature on this subject before giving us the questionable benefit of his views.

Turner would damage central bank independence?
One of his concluding claims is that the above policy might, as he puts it, “damage central bank independence”. Well, amazing as this might seem, advocates of a Turner type policy (who have actually been at it long before Turner adopted / copied their idea) are well aware of the latter potential problem.
That is, a Turner type policy involves a merge of fiscal and monetary policy (as pointed out by Mervyn King here). And given that governments traditionally do fiscal, while central banks do monetary policy, a Turner type policy runs the obvious risk of giving politicians access to the printing press, and secondly, (a point missed by Grenville) the risk of central banks interfering with political decisions.
Well now, there is a simple way of avoiding the two latter risks. As pointed out in this work, it’s to have decisions on STIMULUS taken by some sort of independent committee of economists (in fact EXISTING committees like the Bank of England Monetary Policy Committee would do). While in contrast, STRICTLY POLITICAL DECISIONS, like what proportion of GDP to allocate to public spending, and how that spending is allocated, are taken (as they already are) by the electorate and politicians.
In fact central banks ALREADY HAVE the last word on stimulus, in that if a government goes what a central bank regards as too much fiscal boost, the central bank just negates that boost via an interest rate increase
All in all, to avoid the risk to central bank independence to which Grenville refers, requires a VERY SMALL change to what committees like the Bank of England Monetary Policy Committee already do.

Distorting bank balance sheets.
Grenville’s second concluding claim is that a Turner type policy would distort commercial bank balance sheets in that it would allegedly force them to hold more reserves than they otherwise would. That claim is actually nonsense because it confuses what might be called banks’ NET HOLDING of reserves (or “monetary base”) with their GROSS holdings. I’ll explain.
The large majority of government debt is not held by banks. In the US and UK banks only hold 2 and 10% of government debt respectively. That’s according to Credit Writedowns.
So if a Turner policy is introduced, no doubt the private sector as a whole ends up holding more monetary base. But the vast majority of those “holders” are private sector non-bank entities.
Of course those entities lodge their monetary base holdings at commercial banks who in turn deposit same at the central bank. But commercial banks are simply acting as go-betweens or AGENTS. That is, a Turner policy does needn’t result in commercial banks NET HOLDING of monetary base increasing. I.e. while the amount of monetary base owed by central banks to commercial banks does rise, the amount owed by commercial banks to their customers ALSO RISES.
Moreover, commercial banks are free to use their stock of monetary base to buy government debt or any other asset anytime. Thus Grenville’s idea that some sort of balance sheet distortion is forced on commercial banks doesn’t stand inspection.

Conclusion.
Fifteen love to Turner and other advocates of merging fiscal and monetary policy. I look forward to more attempts at ace serves coming from opponents of that policy.


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