[first]Lord Turner, former chairman of the Financial Services Authority, is moving ever closer to advocating that the state should issue money and spend it into the economy, in the public interest.[/first]
In an interview with the Independent he proposes a (very) roundabout way for this to happen. The ideas draw on his earlier speeches and are mostly consistent with what Positive Money argues (with some caveats). Below, we look at:
- what he’s advocated
- why this is important
- how it’s a roundabout way of issuing debt-free money into the economy
- how close this is to Positive Money’s proposals for sovereign money
- why it’s taboo.
Recap: Quantitative Easing
Turner’s proposal focuses on how to deal with the consequences of the Bank of England’s Quantitative Easing scheme. Through Quantitative Easing, the Bank of England created £375bn of new money (central bank reserves) and used it to buy back £375bn of government bonds from the financial markets (e.g. pension funds and insurance companies). Government bonds are effectively IOUs from the government, and whoever holds the IOUs is owed money from the government.
This means that the government now owes £375bn to the Bank of England – an institution which it owns! The Treasury is still paying interest on these bonds held by the Bank of England, but then the Bank of England returns most of that interest straight back to the Treasury. (Naturally, in practice it’s a little bit more complicated than that – you can find the Bank of England’s full explanation here.)
In effect, through Quantitative Easing, the Bank of England has created money that has been used to ‘buy back’ or ‘pay off’ a large part (around a third) of the national debt. The original holders of the bonds (i.e. the people that the national debt was owed to) are now holding money (in the form of reserves at the Bank of England or deposits at other banks), so they are no better or worse off financially.
However, the Bank of England has always maintained that at some point the bonds bought by Quantitative Easing will be sold back to the financial markets, reversing the process and destroying the money that was originally created. This has allowed them to deny the charge that they are ‘printing money to pay off the national debt’, or ‘monetising the debt’ in banking jargon. Printing money to pay off the national debt is seen as a policy used by desperate governments, and a quick route to a Zimbabwe-style hyperinflation.
What Turner has Advocated
In his interview with the Independent, Turner has suggested that:
[T]he Treasury and the Bank of England should announce that around £50bn of the £375bn of government bonds that the central bank has acquired as part of its monetary stimulus programme will never be sold back to the financial markets.
In effect, this would be acknowledging that part of the national debt had been repaid using money created by the Bank of England for that specific purpose.
Turner advocates that the bonds be converted into non-interest-bearing perpetual debt, which would continue to be held on the Bank of England’s balance sheet. This means that there would be no date for the bonds to ever be repaid, and no interest to pay on them. In practice, this means that this part of the debt has been cancelled. (The practice of converting them to ‘perpetual non-interest-bearing’ bonds is simply a way to keep the accounting and balance sheets in order.)
By doing this, the government’s official headline figure for national debt would be reduced by £50bn. This would give the government some breathing space to slow down the pace of spending cuts.
Why it’s important
There are two potential ways to get new money into the economy:
- Banks create money when they make loans. This relies on there being someone who is willing to go into debt. Most of the money created by banks goes into property or financial markets.
- The Bank of England could create money, without relying on anyone to go further into debt. But the only time that it’s done this on a significant scale – through Quantitative Easing – it’s put the money into financial markets rather than into the government’s budget.
We’re currently fuelling our economy through money creation by banks. There is strong empirical evidence showing that in the current system, we need this money creation to keep the economy growing (See Turner’s speech Escaping the Debt Addiction for more on this.) In other words, to keep the economy growing, households and businesses must keep borrowing at a rate faster than they are repaying existing loans (since banks create money when they make loans and destroy money when any loan principal is repaid).
The problem now is that we’re approaching a dangerous level of private (household and business) debt. Work by Alan Taylor and Morris Shularick has shown that most financial crises and recessions have been triggered by a large rise in the level of private debt (i.e. a large increase in money creation by banks). As The Independent explains:
Lord Turner, who was chairman of the FSA through the 2008-09 global financial crisis, is alarmed by projections from the Office for Budget Responsibility (OBR) showing household debt returning to pre-crisis levels over the coming years as the recovery advances. He argues that this “re-leveraging” could sow the seeds of another crisis.
“If the OBR is right… the private sector turns back to the level of leverage that got us into the mess in the first place,” he said. “If you think that one of the problems that we’ve had is an over-leveraged household sector and a resulting debt overhang effect, [that] is concerning.”
If debt and money creation by banks caused the crisis, then getting them to create even more debt and money isn’t likely to be the solution.
How this is a roundabout way of issuing debt-free money into the economy
The alternative to fuelling the economy with money creation by banks, is to use money that is created by the state (via the Bank of England) without anyone going further into debt. This money could be spent into the economy through government budgets or used to reduce taxes (for example, by lowering regressive taxes or lifting those on lower incomes out of tax altogether).
But arguing for this policy directly is seen as taboo. Turner’s suggestion of effectively cancelling £50bn of the bonds held by the Bank of England is a way of doing the same thing retrospectively. Looked at in hindsight, the Bank of England would have created £50bn of new money, used that to buy back some of the national debt, then converted it into interest-free perpetual debt (an accounting trick to effectively cancel it).
This saves the government annual interest on £50bn of the national debt, freeing up more money for government spending. The additional spending provides demand in the economy, but doesn’t depend on anyone going into debt, so it’s a way of sustaining economic growth without relying on households to keep borrowing from banks.
How this is close to Positive Money’s proposals for sovereign money
In our paper Sovereign Money: Paving the Way for a Sustainable Recovery we argue that the Bank of England should create just £10bn of new money and add this to the central government’s bank account. The government would then spend this money into the economy. Because the money would go directly into the real economy, it would have a significant boost to GDP (up to £28bn depending on how the money was spent).
This would be a more effective debt-free stimulus to the economy than the approach of cancelling the debt, but both approaches recognise that money can be created by the state as well as by banks.
Why it’s Taboo
The knee-jerk reaction of many economists to the idea of states creating money is that it will inevitably create inflation:
This so-called “monetisation” would represent a major taboo in the world of economic policymaking where it is generally believed that such debt cancellations inevitably result in destructive inflation.
Lord Turner dismisses the argument that monetisation would stoke inflation as “not true” and argues monetary impact of the debt cancellation can be offset by compelling banks to hold larger reserves of liquidity at the Bank of England.
Indeed, the argument that this would be inflationary completely misses the point. The whole point of QE was to cause inflation. Any inflationary impact occurred when the money was initially created and used to buy the bonds. (In practice, the inflation has almost all been in financial asset prices – in other words, QE blew up a bubble in the stock and bond markets.)
If QE is reversed and the bonds are sold back into the market this will have the opposite effect to the original QE, and would therefore be deflationary. (Again, in practice it would deflate bond and stock prices, rather than affecting the real economy.) But cancelling part of the debt would have no impact on inflation or deflation.
(As an aside, it’s odd that many economists believe that state-issued money would cause disastrous inflation, and remain blind to the fact that money creation by banks is already fuelling double-digit inflation in house prices right at this moment.)
Lord Turner is going out on a limb to warn against the government’s policy of fuelling the ‘recovery’ by allowing banks to create money in the reckless manner that caused the financial crisis. He’s advocating increasingly radical (but increasingly essential) alternatives, which are steps towards the approach advocated by Positive Money.
Along with Martin Wolf’s call, in the Financial Times, to ‘strip banks of their power to create money‘ we’re seeing the debate about money creation break into the mainstream policy debate. We live in exciting times…