Debt, Money and Mephistopheles: How do we get out of this ... · Japanese government and corporate...

Debt, Money and Mephistopheles: How do we get out of this mess?

Cass Business School6 February 2013

Adair Turner

11

Monetary policy and macro-demand: Two issues

Targets:- Inflation rates or price levels- Nominal GDP growth rates or levels

Tools to achieve targets:- Fiscal or monetary or macro-prudential- Interest rates or QE or credit easing- Helicopter money

2

Devilish money creation: Faust Part II

“All this activity degenerates into inflation, destroying the monetary system because the money rapidly

loses its value”

Jens Weidman, Money Creation and Responsibility, September 2011

33

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”

“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.”

Milton Friedman, A Monetary and Fiscal Framework for Economic Stability, America

Economic Review, Vol 38, June 1948

Henry Simons, Rules and Authorities in Monetary Policy, The Journal of Political Economy, Vol 44, No. 1, February 1936

44

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”

“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.”

Milton Friedman, The Optimum Quantity of Money, Chapter 1, (1969)

John Maynard Keynes, The General Theory, Chapter 10, Section 6 (1936)

55

1. Macro demand levers and effects

2. Friedman 1948: monetary policy and the structure of banking

3. Financial stability and macro-demand management: the crucial role of leverage

4. Appropriate targets: prices or nominal GDP? Rates or levels?

5. Conventional and unconventional monetary policy: limits to effectiveness and potential adverse effects

6. Pure fiscal policy: limitations and risks

7. Overt money finance: Definition and advantagesDangers and constraints Central bank independence

8. Possible implications today: Japan, US, Eurozone and UK9. Conclusions10. Mephistopheles, Money and Debt

66

Levers and effects

Macro-Prudential policy:- Bank capital and liquidity standards

Aggregate Nominal Demand = Nominal GDP

Prices

Real output

Central Bank private credit support: - US “credit easing”- UK “FLS”

Monetary policy: - Interest rates- QE- Forward guidance

Fiscal policy: deficits or surpluses

Macro-Prudential policy:- Bank capital and

liquidity

77

Levers and effects

Aggregate Nominal Demand

Prices

Real output




O.P.M.F.


88

Levers and effects


Prices

Real output

Division determined by• Spare capacity in labour or physical capital• Flexibility of price setting processes in

labour or product markets

99

The “independence” assumption


Prices

Real output

Central Bank private credit

support


Monetary policy

Fiscal policy

Macro-Prudential

Division of the effect between prices and real output is

independent of the tools used to stimulate nominal demand

O.P.M.F.

1010

Possible contraventions of “independence”


Prices

Real output


support

Monetary policy

Macro-Prudential

Supply enhancement?

Fiscal policyO.P.M.F.

Unconventional monetary policy or O.P.M.F. create

expectations of future price effects?

Fiscal expenditure or credit support targeted to achieve supply increase as well as

demand?

1111

“The essence of [the] proposal is that it uses automatic adaptationsto the current income stream to offset, at least in part, changes inother segments of aggregate demand and to change appropriatelythe supply of money. Under the proposal, governmentexpenditures would be financed entirely by tax revenues or thecreation of money, that is, the issue of non-interest bearingsecurities… The chief function of the monetary authority [would be]the creation of money to meet government deficits and theretirement 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

1212

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)

1313

Two simplifying assumptions

Stable relationship between money supply and money GDP (constant velocity)

All money is base money: no fractional reserve banks; no private money creation

“A reform of the monetary and banking system to eliminate both the private creation or destruction of money and discretionary control of the growth

of money by the central bank authority”

(Friedman, 1948)

1414

From fractional reserve to 100% reserve banking

100% Reserve Banking

Notes & Coins

Reserves

Central Bank Commercial Banks

Money supplyA L

Reserves Deposits

Deposit money = Reserves at central bankTotal money supply = Base money

Deposit money = Multiple of reserves at central bankTotal money supply = Multiple of base money

Fractional Reserve BankingCentral Bank Commercial

BanksMoney supplyA L

Notes & Coins

Reserves Notes&

coins &

bank deposits

A L

Reserves

Loans

Deposits

Notes&

coins &

bank deposits

1515

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.

1616

Arguments for fractional reserve banks: Up to a point

Some private credit and money creation, may:

Be essential to optimal mobilisation of savings

Facilitate welfare enhancing smoothing of consumption across life cycle

• Abolishing fractional reserve banks almost certainly not optimal

• But good argument for dramatically increasing

− The fraction of liquid reserves and/or

− The fraction of capital resources

See Adair Turner “Monetary and Financial Stability: Lessons from the Crisis and from some old Economics Texts”, South Africa Reserve Bank, November 2012.

1717

Two (lost) insights of early laissez faire writers

Banking is special: arguments for laissez faire in other sectors of the economy are not applicable

Monetary and financial stability are closely interlinked

1818

1. Macro demand levers and effects

2. Friedman 1948: monetary policy and the structure of banking

3. Financial stability and macro-demand management: the crucial role of leverage

4. Appropriate targets: prices or nominal GDP? Rates or levels?

5. Conventional and unconventional monetary policy: limits to effectiveness and potential adverse effects

6. Pure fiscal policy: limitations and risks

7. Overt money finance: Definition and advantagesDangers and constraints Central bank independence

8. Possible implications today: Japan, US, Eurozone and UK9. Conclusions10. Mephistopheles, Money and Debt

1919

Three drivers of financial instability

Debt contracts create specific risks

Unregulated bank credit and private money creation is inherently unstable

Lending secured against real assets can be strongly pro-cyclical

Real economy leverage, credit creation dynamics, and credit/asset price cycles are

crucial macro-economic variables, and phenomena

2020

Leverage in the real and financial sectors

Source: Oliver Wyman

UK debt as a % GDP by borrower type(1987-2007), Debt Liabilities on B/S

Household

Corporate

Financial0%

100%

200%

300%

400%

500%

600%

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

USA debt as a % GDP by borrower type(1929-2007)

Household

Corporate

Financial

1987

1929

1935

1941

1947

1953

1959

1965

1971

1977

1983

1990

1996

2002

2007

10%50%

100%

150%

200%

250%

300% 1987

2121

Private non-financial corporate deposits and loans: UK 1964 – 2009

Source: Bank of England Tables A4.3, A4.1

0%

5%

10%

15%

20%

25%

30%

35%

40%

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

% o

f GD

P

Securitisations and loan transfers Deposits Loans

2222

Household deposits and loans: UK 1964 – 2009

Source: Bank of England, Tables A4.3, A4.1

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

% o

f GD

P

Securitisations and loan transfers Deposits Loans

2323

Private credit to GDP ratio and growth

Source: S. Cecchetti, BIS Working Paper No. 381 "Reassessing the impact of finance and growth"

2424

Lending to UK business

Source: Bank of England “Trends in Lending”

-20

-10

0

10

20

30

40

5019

64

1970

1976

1982

1988

1994

2000

2006

2012

All currency loans

Percentage changes on a year earlier

2525

Lending to individuals

-5

0

5

10

15

20

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Percentage changes on a year earlier

Secured

Unsecured

Individuals

Source: Bank of England “Trends in Lending”

2626

Japan-policy rate vs credit growth per annum

-8

-4

0

4

8

12

16

Dec

-85

Dec

-87

Dec

-89

Dec

-91

Dec

-93

Dec

-95

Dec

-97

Dec

-99

Dec

-01

Dec

-03

Dec

-05

Dec

-07

Dec

-09

Dec

-11

Private credit growth (%pa) BoJ Policy rateSource: Datastream

%

2727

Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012

Source: IMF, Bank of Japan Flow of Funds Accounts

-15

-10

-5

0

5

10

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

PNFCs Government

%

2828

Japanese government and corporate debt:1990 – 2010

Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations

% G

DP

0

50

100

150

200

250

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20010

Banking lending to non-financial corporates General Government debt

2929

Shifting leverage: private and public debt-to-GDP

Source: ONS Note: PNFC = private, non-financial corporates; Public = central and local government

UK

0

20

40

60

80

100

120

140

Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011

% G

DP

Household Public PNFCs

Source: BEA Note: PNFC = private, non-financial businesses; Public = federal, state and local government

US

0

20

40

60

80

100

120

Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011

% G

DP


Source: ECB Note: PNFC = private, non-financial corporates; Public = central and local government

0

20

40

60

80

100

120

140

160

Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011

% G

DP


Spain

3030

Alternative possible targets

Exclusively price focused Price and real output / employment focused

Alternative inflation rate measures (e.g. excluding “one-ff” tax or commodity price effects

Higher inflation rate (permanently or for a period of time)

Guidance implying loose policy even after inflation rate back on target

Price level trend

Circumstance contingent future guidance (loose policy till unemployment below x%)

Money GDP growth rate (as permanent rule or temporarily)

Money GDP level trend

Blanchard et all

Federal Reserve

, Autumn

2012

Woodford, August

2012Carney,

December 2012

3131

UK inflation: Bank of England forecasts and actual

0123456

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

2010

Q4

2011

Q1

2011

Q2

2011

Q3

2011

Q4

2012

Q1

2012

Q2

2012

Q3

2012

Q4

2013

Q1

2013

Q2

Aug 09 Projection Aug-10 Aug-11Actual CPI Inflation target

%

32

Arguments for changed targets

High potential for non-inflationary growth

Erosion of excess debt levels (public or private) via higher inflation

Forward commitments to future accommodative policy

3333

Public debt to GDP: US and UK

0

50

100

150

200

250

300

1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980

% G

DP

Source: DMO, ONS

National debt as % of GDP

3434

GDP Growth rates 1950 – 1970

0 2 4 6 8 10 12 14 16

Japan

France

Germany

UK

US

0 2 4 6 8 10 12 14 16

Japan

France

Germany

UK

US

% p.a.

Real annual average GDP growth % Nominal annual average GDP growth %

Source: BEA (US), ONS (UK), FSO (DE), Cabinet Office (JP), Madison, FSA calculations

35

Arguments for changed targets

High potential for non-inflationary growth

Erosion of excess debt levels (public or private) via higher inflation

Forward commitments to future accommodative policy

36

New targets?

Potential for non-inflationary growth

Erosion of debt via inflation

Forward commitments to accommodative

policy

Reasonable case to consider alternatives

But as temporary not permanent regime change

Particular attractions in:

Circumstance contingent pre-commitment (Federal Reserve policy)

Taking account of nominal GDP level… but not Woodford’s “return to trend”approach

?

3737

Levers and effects

Aggregate Nominal Demand = Nominal GDP

Prices

Real output





38

Monetary, credit support and macro-prudential levers beyond the ZLB

Standard QE – buying government bonds

Wider QE – private bonds, equity, property, FX

Liquidity support – LTRO

Direct credit subsidy – FLS

Macro-prudential policy – relaxation of capital or liquidity standards

3939

Central Bank policy rates

Source: Central Banks

0

1

2

3

4

5

6

Jan-0

8Apr-

08Ju

l-08

Oct-08

Jan-0

9Apr-

09Ju

l-09

Oct-09

Jan-1

0Apr-

10Ju

l-10

Oct-10

Jan-1

1Apr-

11Ju

l-11

Oct-11

Jan-1

2Apr-

12Ju

l-12

Oct-12

Jan-1

3

European Central Bank

Bank of England

Bank of Japan

US Federal Reserve

4040

Central Bank balance sheets as %GDP

0

5

10

15

20

25

30

35

Sep-

97

Sep-

98

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Sep-

05

Sep-

06

Sep-

07

Sep-

08

Sep-

09

Sep-

10

Sep-

11

Sep-

12

Japan

0

5

10

15

20

25

30

35

Sep-

97

Sep-

98

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Sep-

05

Sep-

06

Sep-

07

Sep-

08

Sep-

09

Sep-

10

Sep-

11

Sep-

12

Japan

0

5

10

15

20

25

30

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

UK

0

5

10

15

20

25

30

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

UK

0

5

10

15

20

25

30

35

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

EU

0

5

10

15

20

25

30

35

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

EU

0

5

10

15

20

25

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

US

0

5

10

15

20

25

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

US

Japan UK

USEU

41

Monetary, credit subsidy and macro-pru levers

Potential limitation?Levers work via indirect channels:

Credit growth – demand and supply

Search for yield

Asset price / wealth effects

Adverse side effects?

Potentially limited if:

Borrowers focussed on strengthening balance sheets

Long as well as short term interest rates approaching ZLB

Low interest rates over many years (decades?)

Stimulus to private leverage

Hair of the dog that bit us

Relaxed prudential standards → financial stability risks

Exchange rate spill-over effects

4242

Japan – 10 year nominal yield

Source: Bloomberg

0

1

2

3

4

5

6

7

8

9

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Jan-

13

%

4343

UK trends in lending: % 12-month growth rates

(% 12-month growth rates)

-10

-5

0

5

10

15

20

2007

2008

200 9

2 010

201 1

2 012Q1

2012Q2

2 012Q3

201 2Q4

Lending to UK businesses Secured lending to individualsConsumer credit

Source: Trends in Lending, data as of 04/01/2013

%

4444

Gross lending to and repayments by UK non-financial businesses (£bn)

0

10

20

30

40

50

6020

11 Q

2

2011

Q3

2011

Q4

2012

Q1

2012

Q2

2012

Q4

SME gross lending LB gross lending SME repayments LB repayments

Source: Bank of England, Trends in Lending, January 2013

45

Funded fiscal stimulus

Advantage:

But offset by:

Puts money directly into the “Income Stream”

Crowding out Ricardian equivalence

46

Delong and Summers: The case for pure fiscal stimulus

“When interest rates are constrained by the zero

nominal lower bound, discretionary fiscal policy can

be highly efficacious as a stabilisation policy tool.

Indeed, under … plausible assumptions, temporary

expansionary fiscal policies may well reduce long run

debt financing burdens”

Fiscal multipliers low in ‘normal times’ because central bank Is itself following appropriate monetary

policy to achieve non-inflationary growth

Will respond to fiscal stimulus by monetary tightening

Fiscal multipliers far higher when interest rates at the ZLB and if central bank committed to keeping them there

Stimulus to growth can avoid ‘hysteresis’ effects which will otherwise depress long-term output potential

4747

Japanese Government debt as % of GDP

Source: Bank of Japan, data as at end 2012, Japan Post Holdings accounts end March 2012

0

50

100

150

200

250

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Minus Bank of Japan

Minus Japan Post

Minus domestic commercial banks

46% of GDP

Gross debt minusGovernment + social security holdings

30.6% of GDP

33.7% of GDP

%

48

Bernanke 2003: The case for a money financed tax cut

“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”

Important to be clear “that much or all of the increase in the money stock is viewed as permanent”

Consumers and business will spend the tax cut since “no current or future debt service burden has been created to imply future taxes” (i.e., no Ricardian equivalence offset)

Debt to GDP ratio will fall: no increase in nominal debt but “nominal GDP would rise owing to increased nominal spending”

Same principle “could also support spending programmes to facilitate industrial restructuring, for instance”

49

Advantages of OMF

Versus monetary, credit support and macro-pru

stimulus

Not offset by:

Works directly

Crowding out Ricardian equivalence

Versus funded fiscal stimulus

5050

Levers and effects


Prices

Real output




O.P.M.F.


5151

0

10

20

30

40

50

60

1940

1941

1942

1943

1944

1945

1946

1947

1948

1949

1950

1951

1952

1953

1954

1955

Post-facto money finance: US 1940 to 1951

Large wartime budget deficits ‘funded’ by government debt issuesFederal Reserve

commitment to keep interest rates at 2.5% -buying bonds to achieve target

Source: Friedman and Schwarz, Monetary History of the United States

Post-facto permanent money financeNo subsequent

reversal / ‘exit’

High powered base money

5252



0

50

100

150

200

250

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Minus Bank of Japan

Minus Japan Post


46% of GDP


30.6% of GDP

33.7% of GDP

%

5353

The “independence” assumption


Prices

Real output


support


Monetary policy

Fiscal policy

Macro-Prudential

Division of the effect between prices and real output is

independent of the tools used to stimulate nominal demand

O.P.M.F.

54

OMF: Technically safe, politically dangerous

“The proposal has of course its dangers. Explicit control of the

quantity of money by the government and the explicit creation of money to support

actual government expenditures may establish a climate

favourable to irresponsible government action and to

inflation”

Admitting possibility of OMF carries political economy risks

OMF has taboo status

Taboos can be useful constraints

Milton Friedman, 1948

55

OMF: A policy that dare not speak its name

Optimal policy requires “Policy action that should stimulate spending immediately, without relying too much on expectational channels”“The most obvious source of a boost to aggregate demand that would not depend solely on expectational channels is fiscal stimulus”Need to be clear that some part of “the increase in the base money is intended to be permanent”

Michael Woodford, August 2012

5656Source: McCulley and Pozsar

56

Varying actual and appropriate policies: McCulley and Pozsar’s framework

5757

57

Source: McCulley and Pozsar

Private and public leverage cycles

5858

58

y Leveraging "M M" Deleveraging

Conventional Unconv. Radical Nuclear x

Rates "Z B" QE

FMCMonetary Independence ~

Austerity

Policy

B"

Fiscal

"B

Surpluses

Private Sector

Deficits Surpluses

Stimulus

Deficits

Plain Asset Purc

hases

Reve

rse Vo

lcker Moment

Helicopter

Mone

y-


Varying actual and appropriate policies: McCulley and Pozsar’s framework

59

“It is important to recognise that the role of an independent central bank is different in inflationary and deflationary environments. In the

face of inflation, which is often an associated with excessive monetisation of government debt, the virtue of an independent central

bank is its ability to say “NO” to the government. [In a liquidity trap] however, excessive money creation is unlikely to be the problem, and

a more cooperative stance on the part of the central bank may be called for. [Under these circumstances] greater cooperation for a

time between the central bank and the fiscal authorities is in no way inconsistent with the independence of the central bank”.

Bern Bernanke, 2003

60

Constraining OMF with rules and authorities

Amount of OMF determined by central bank in pursuit of defined target (inflation or, temporarily, nominal GDP)

Amount limited to cyclical element of deficit (as determined by independent authority e.g. OBR)

OMF used only for one-off bank recapitalisation

6161

Two Policy options

Several £100bns of QE with commitment to future reversal

Funding for lending

Relaxation of bank capital and liquidity standards

+

+

Several £10bns of OMF of increased fiscal deficit (tax cuts or public spend increasing) … with commitment that this will be permanent

Option 1 Option 2

Which will:

Be most effective in stimulating nominal demand?

Have least adverse side-effects?

62

Implications by country and currency zone

Bernanke was right

Current policy mix optimal, may post-fact be OMF, but is it worth saying so?

Optimal policy blocked by incomplete currency union

Supply constraints may be as important as demand

6363

Fiscal adjustment required for long-term debt sustainability

Actual today Required for debt sustainability

Debt as % of GDP 2011

Cyclical adjusted primary balance

2011

Cyclical adjusted primary surplus2020-2030

Required adjustment

Spain 69

UK 82

US 103

Italy 120

Japan 126

Gro

ss D

ebt

Net

D

ebt

-5.1

-3.7

-5.3

2.0

-7.7

5.5

5.7

7.5

12.6

7.6

+ 10.6

+ 9.4

+ 12.8

+ 20.3

+ 5.6

To get to 60% debt

to GD

P by 2030

To get to 80% debt to GDP

6464

Money finance in Japanese system?

Close to money financing of deficits Closer still if government owns banks Which it does in case of Japan Post

Money claims of Japanese households & corporates

Current and deposit accounts at zero interest

Government bonds at close to zero interest

Commercial Banks

Government

6565



0

50

100

150

200

250

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Minus Bank of Japan

Minus Japan Post


46% of GDP


30.6% of GDP

33.7% of GDP

%

6666

Nominal GDP in four major economic areas: 2007 – 2011

GDP (Q1 2007 = 100)

85

90

95

100

105

110

115

Q1

2007

Q2

2007

Q3

2007

Q4

2007

Q1

2008

Q2

2008

Q3

2008

Q4

2008

Q1

2009

Q2

2009

Q3

2009

Q4

2009

Q1

2010

Q2

2010

Q3

2010

Q4

2010

Q1

2011

Q2

2011

UK US EA JPN

Source: ONS, BEA, Eurostat, Cabinet Office (Japan)

Q1 2007 = 100

6767

Developed economies’ GDP growth

Q1 2007 = 100


6868

Breaking down of NGDP growth from trough (2009) to peak

∆ Nominal GDP

∆ Prices (GDP deflator)

∆ Real output

UK: +8.1%US: +5.2%Eurozone: +3.8%

UK: +2.2%US: +6.5%Eurozone: +3.1%

UK: +10.4%US: +12.0%Eurozone: +7.1%

6969

Breakdown of NGDP growth from trough: 2009 to 2012

0 20 40 60 80 100

Eurozone

US

UK

Share of NGDP change due to pricesShare of GDP change due to real output

% % % % % %

70

Conclusions

Leverage and the credit cycle matter a lot Banks are different – arguments for freer markets don’t apply Excess leverage crises are followed by attempted deleveraging – which changes appropriate macro-demand

policy In the deleveraging cycle, monetary, credit support and macro prudential levers alone may

… become powerless… have adverse side effects

Fiscal multipliers are higher when interest rates are at ZLB… but long term debt sustainability matters

Governments and central banks together never run out of ammo: OMF is possible and May have less adverse side effects In technical terms, is no more inflationary than other levers

But the political economy risks of OMF are huge So need strong disciplines to constrain misuse

Overt money finance should not be a taboo subject

7171

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

72

END

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