The following post is merely the authors attempt to pick out some of the key points of Turner’s speech, and provide a brief commentary where required. It is not an analysis, and neither should it be taken that Positive Money agrees with all of what Turner is saying. Instead, the sole purpose of this post is to distill Turner’s 46 page speech into something a little more manageable, and in particular to highlight his thoughts on Overt Monetary Financing (OMF), which is in short creating money and spending it into circulation. If this sounds familiar, it’s because Positive Money have been advocating something similar since June 2010!
The speech actually details a whole range of other types of intervention, and is well worth reading for those that have the time (available here, watch the speech here)
Turner’ speech starts by noting that for monetary policy to achieve a specific target (i.e. growth, low and stable inflation, unemployment, etc.) the correct tool is required:
Turner does not agree that the current banking system should be abolished, arguing that a) debt contracts have arisen naturally as a way of fulfilling human desires, and b) that the current banking system allows maturity transformation which is economically beneficial. As this post is merely an outline of the points Turner raises in his paper we will not delve too deeply into the counterarguments to his points, other than to note that both debt contracts and maturity transformation are possible under the Positive Money proposals (as well as the Chicago Plan), and as a result these are not grounds for rejecting monetary reform.
Moving on, in the next part of his speech Turner argues that: “The financial crisis of 2007 to 2008 occurred because we failed to constrain the financial system’s creation of private credit and money; we failed to prevent excessive leverage.” This is of course also the Positive Money explanation of the crisis, which derives directly from the work of economists such as Hyman Minsky.
Turner then goes on to point out that since the crisis banks are making new loans less quickly than old loans are being repaid, both as a result of banks not wanting to make new loans and also due to a lower demand for new loans from the private sector. This in turn:
- Monetary policy acting through short or long term interest rates loses stimulative power.
- Fiscal policy offsets may be constrained by long-term debt sustainability concerns.
- And slow growth in nominal GDP makes it more difficult to achieve attempted deleveraging in the private sector, or to limit the growth of public debt as a % of GDP.
- What are the appropriate targets of macroeconomic policy?
- And what policy tools should we use to achieve them?”
Moving on to look at the response to the crisis, Turner notes that:
- “He proposed “a tax cut for households and businesses that is explicitly coupled with incremental BoJ purchases of government debt, so that the tax cut is in effect financed by money creation”
- He suggested that it should be made clear “that much or all of the increase in the money stock is viewed as permanent”
- He argued that consumers and businesses would likely be willing to spend their tax cut receipts since “no current or future debt service burden has been created to imply future taxes”…
- And he argued that the policy would likely produce a fall in the Japanese government debt to GDP ratio, since the nominal debt burden would remain unchanged while “nominal GDP would rise owing to increased nominal spending”
- And while his main illustrative proposal was for a tax cut, he noted that the same principle of a money financed fiscal stimulus “could also support spending programs, to facilitate industrial restructuring, for instance””
- Compared with the [other] monetary policy options … it is more direct and certain in its first order effect. Monetary, credit support, and macroprudential policy levers work through the indirect mechanism of stimulating changes in private sector borrower and investor behaviours, and may therefore be ineffective if behaviour is driven by deleveraging during a balance sheet recession”. OMF, because it finances an increased fiscal deficit, results in a direct input to what Friedman labelled “the income stream”. As Bernanke notes, this means “that the health of the banking sector is irrelevant to this means of transmitting the expansionary effects”, making concerns about “broken channels of monetary transmission” irrelevant.
- But unlike the funded fiscal policy stimulus considered in Section 6, the stimulative effect of a money financed increase in fiscal deficit will not be offset by crowding out or Ricardian equivalence effects, since no new interest bearing debt needs to be publicly issued, and no increased debt burden has to be serviced in future.
Of course, many would argue that government creation of money is bound to be highly inflationary. Turner addresses these points as follows:
- It is no more inflationary than other policy levers provided the “independence” hypothesis holds. If spare capacity exists and if price and wage formation process are flexible, the impetus to nominal demand induced by OMF will have a real output as well as a price effect, and in the same proportion as if nominal demand were stimulated by other policy levers. Conversely if these conditions do not apply, the additional nominal stimulus will produce solely a price effect whether it is stimulated by OMF or by any other policy lever.
- And the impacts on nominal demand and thus potentially on inflation will depend on the scale of the operation: a “helicopter drop” of £1bn would have a trivial effect on nominal GDP: a drop of £100bn a very significant effect and as a result create greater danger of inflation. And if the stimulative effect of OMF subsequently proved greater than anticipated or desired, it could be offset by future policy tightening, whether in the extreme form of Friedman’s “money withdrawing fiscal surpluses” or through the tightening of bank capital or reserve requirements.
- “If Herbert Hoover had known in 1931 that OMF was possible, the US Great Depression would have been less severe.
- If Germany’s Chancellor Brüning had known then that it was possible the history of Germany and of Europe in the 1930s might have been less awful. Hitler’s electoral breakthroughs from a 2.6% vote in the elections of May 1928 to 37.4% in the election of July 1932 were achieved against a backdrop of rapid price falls not inflation.
- And while Japan’s deflationary experience of the last 20 years has been far less severe than that of the 1930s, (as a result, Koo argues, of fiscal deficits that were effective despite being funded) there is a very strong case that Bernanke was right and that if Japan had deployed OMF 10 or 15 years ago, it would be in a much better position today, with a higher price level, a higher level of real GDP, and a lower government debt burden as a % of GDP, but with inflation still at low though positive levels. And it is possible that there are no other policy levers that could have achieved this.”
- The level of leverage in both the real economy and the financial system are crucial variables which we dangerously ignored pre-crisis.
- … future macro-prudential policy should reflect a judgment on maximum desirable levels of cross economy leverage, as well as on desirable growth rates of credit. A wide range of policy levers may be required to contain leverage.
- First, that in the deflationary, deleveraging downswing of the economic cycle, we may need to be a little bit more relaxed about the creation, within disciplined limits, of additional irredeemable fiat base money.
- But second, that in the upswing of the cycle we should have been massively more worried than we were pre-crisis about the excessive creation of private debt and private money; and, that we should be wary of relying on a resurgence of private debt and leverage as our means of escape from the mess into which excessive debt creation landed us.”