Last night Adair Turner gave a speech at the Mansion House in the City of London and set out his stall to become the next Governor of the Bank of England. There are a couple of ways in which in true Yes Minister style he is ideally equipped for the job. Firstly he was a advocate for the UK to join the Euro so on one of the most important policy issues he was completely wrong. It sends a chill down my spine thinking of the mess we would be in if our housing market had boomed like Spain’s or Ireland’s did in response to interest-rates set for Germany’s benefit, let’s face it we have problems enough without that too. Also as chairman of the FSA he was not responsible for pre-2008 problems but nothing was done about the LIBOR scandal with the suspicion that it was hushed up.
Indeed last night to use modern vernacular Lord Turner felt the need to “fess up” about another recent policy error he has been involved in via his role on the Bank of England’s Financial Policy Committee.
For the last year, the FPC has been struggling with a trade-off – and I suspect our communication might have been clearer if we had been more explicit about how difficult that trade off is.
What he means is that the Bank of England has been pursuing policies which are mutually exclusive. Trying to get banks to lend whilst telling them to hold more capital also known as restricting their ability to lend! It is amazing how often the so called “Great and the good” are in fact neither.
So in Yes Minister terms the claimed novelty of having a Governor who is both honest and intelligent seems unlikely to occur should Lord Turner get the job.
What did he say?
There was a crucial component in the speech which to give them credit BBC News 24 broadcast live and it was this and the emphasis is mine.
So optimal policy also needs to include a willingness to employ still more innovative and unconventional policies, and to consider the combined impact of multiple policy levers – monetary policy, Bank of England liquidity insurance, prudential regulation and direct support to real economy lending – which we used either to consider quite separately, or else avoid entirely.
Okay so what does he mean?
Quantitative Easing is admitted to be a failure
I believe that this section of his speech is revealing enough as it confesses to issues with the effects of QE but once decoded I think it is as near as we have got to an admission that it has failed in the UK.
But quantitative easing alone may be subject to declining marginal impact, the economy facing a liquidity trap in which replacing private sector holdings of bonds with private sector holdings of money has little impact on behaviour and thus on demand
In a section that was probably hoped to be missed there was an admittal that QE has been inflationary. It was tucked behind the word growth-of which by contrast we have had precious little- but it was there. Phrases such as “slightly higher ” and “as best we can tell” are different to what Lord Turner would have told us when it started.
What alternatives are there?
Negative Interest Rates
I discussed this subject yesterday and to my mind this would be a likely option for “unorthodox” policies. It is already happening in some countries and frankly given its set-up I have been surprised that the current Monetary Policy Committee has not moved nearer to it.
However I am not a fan because I believe that we are already in a zone similar to the concept of a liquidity trap where cuts in interest-rates have less and less effect. As we moved below 1.5% to 2% I not only believe that they had little effect but the effect may have moved backwards. I will expound on this in subsequent articles but I believe that the effects on savers, inflation, confidence and expectations have counter-balanced any of the gains that economic textbooks predict. Going negative would be likely to have more negative effects in my opinion.
Cancelling government debt or helicopter money
Robert Peston of the BBC has suggested that this is an option Lord Turner favours and it made me wonder if Lord Turner had whispered it to Robert’s father on the House of Lords benches. Here is his view.
it is understood he believes the Bank of England should consider telling the Treasury it never has to repay some of the £375bn of government debts the Bank acquired through quantitative easing
Actually he is confused on this point as if you think about it the Treasury would have to give the Bank of England permission to tell it that the debt is cancelled. Oh what a tangled web and all that!
What would this mean?
As we stand right now we have seen the Bank of England buy government bonds in return for money. So the seller emerges with cash/money/liquidity and right now there is just under £366 billion of such funds in existence (it will reach the £375 billion in three weeks time at current purchasing rates). It was supposed to give an economic stimulus but as time goes by ever more of its previous supporters drop by the wayside (and hope that we do not notice that).
So if the bonds are cancelled there is no mechanism for the cash to be returned and our monetary system would remain with an extra £366 billion in it.
Does this matter Shaun?
Because of the nature of our economic crisis the immediate impact would be minor compared to the longer-term effects when we (hopefully) have an economic recovery. I have argued plenty of times on this blog that the UK ‘s monetary transmission mechanism is broken and that we have many of the symptoms of a liquidity trap.
However even Lord Turner admits that QE has created some inflation and this does have impacts. In such a time where many are facing severe constraints on their income even inflation on a path 1% or 2% higher than otherwise will be like a noose around their necks especially if we recall that we have already had three years of this meaning that real wages have and are still falling. Regular readers will know that I worry about our poorest citizens and would like to point out one more time that such a policy will hurt them the most.
What about going forwards?
The situation of inflation somewhat higher than otherwise would persist until we reach the hoped for nirvana of a genuine economic recovery. At this point the extra money in the system will return to full or if you like normal power and if UK economic history is any guide will give us a more sustained burst of inflation. How high and how sustained will depend on how quickly the Bank of England responds to it.
When this occurs I feel that at best the Monetary Policy Committee is likely to dither. They will be terrified of cutting off the recovery by their actions and so they will wait and wait before they act to remove this extra liquidity. In short they will have a prima facie failure as they will be acting like the politicians they were supposed to be an improvement on. So the monetary stimulus will remain at exactly the wrong point in our economic cycle and will cause our economy to overheat one more time.
So for such a policy to work you have to have faith in the integrity and ability of the Bank of England just as its reputation on both fronts is at an all-time low. This moves me onto a subject I intend to explore further in future articles which is that such failures introduce a negative influence on the economy via confidence and expectations. Sometimes intangible influences are more powerful than tangible ones.
Where is this leading?
I suspect that cancelling public-sector debt would also be combined with an increase in government spending or would give the opportunity to do so. With our national debt cut “at a stroke” so to speak it would be argued that we have more scope for expansionary fiscal policy. I do not want to get too much into the debate as to whether this is a good idea today apart from pointing out a consequence of this too.
To work this would require a belief that the extra public spending would be reversed in the future. As over our economic history we have proved capable of reducing the growth rate of public spending at best this is not entirely reassuring! So higher taxation would be required assuming of course they choose to cut back. Hopefully some of this would be offset by some economic growth but that is by no means as certain as its advocates would have you believe.
So we would be in danger of overheating quickly in any recovery and in an attempt to get ourselves out of one mess we would have lept into another and that is on a relatively optimistic scenario. As Oliver Hardy regularly said.
That’s one fine mess you got me into