With developed economies stuck in a high-debt and low interest rate trap, the former head of Britain’s financial watchdog believes central banks should break a long-held taboo and finance governments directly.
6 minute read
The Independent called him Britain’s technocrat supreme. He held several high-profile roles, including director general of the country’s main business lobby group, the Confederation of British Industry, and chaired three government commissions on low pay, pensions and climate change.
But Adair Turner is probably best known as the former chairman of the Financial Services Authority (FSA), the UK’s financial regulator between 2001 and 2013 [it was superseded by the Financial Conduct Authority and Prudential Regulation Authority]. He took up the role in September 2008, just five days after Lehman Brothers filed for bankruptcy. During his five-year stint, he played a leading role in the post-crisis redesign of global banking and shadow banking regulation.
At the helm of the FSA, Baron Turner of Ecchinswell risked the ire of commercial banks when he famously described some of their activities as “socially useless”. More than a decade on, he is in danger of further censure – this time from central banks. In his 2015 book Between Debt and the Devil, Turner attempted to debunk what he claims is the big myth about fiat money – the erroneous notion that printing money will lead to harmful inflation.
With the world heading for the deepest recession in nearly a century and fierce debate over the success of the monetary policy experiments of recent years, Lord Turner tells AIQ central banks should bite the bullet and finance governments directly to stimulate economies.
You have written previously about the benefits of monetary finance. Does this mean you are a convert to the ideas of Modern Monetary Theory?
I think there is a subtle, but important, distinction. At one level, as people have pointed out, MMT is a bit of a misnomer. It’s not ‘modern’ monetary theory at all. It was all laid out by Milton Friedman in his 1948 article A Monetary and Fiscal Framework for Economic Stability. If the central bank printed money and either directly distributed it to individuals or gave it to the government to spend, you would stimulate the economy. That is so obvious that I don’t think anybody could really deny it.
The impact on aggregate nominal demand depends on how much you do
It is also pretty obvious the impact on aggregate nominal demand depends on how much you do. If Donald Trump suddenly told the Federal Reserve to print ten million one-dollar bills, scatter them from a helicopter and let people pick them up and spend them, the impact on inflation and nominal GDP would be negligible because $10 million is such a trivial part of a $20 trillion economy.
If, on the other hand, he ordered them to print $100 trillion, the result would be hyperinflation. It is as simple as that. It depends how much you do.
Why is there so much resistance to monetary financing from central banks?
If you think we shouldn’t be doing monetary finance now because it will cause inflation, then we shouldn’t be cutting interest rates and we shouldn’t be doing quantitative easing (QE) and we shouldn’t be providing liquidity to banks. Those are all ways of stimulating nominal demand.
That is why most orthodox economists engage in obfuscation, pretending monetary finance is in some sense impossible. They are terrified that if we admit it is possible, politicians will do it to excess and we will end up with Weimar Republic or Zimbabwe situations – in other words, you will never be able to do a limited amount.
The interesting questions about monetary finance are therefore not about the technical possibility. Instead, they relate to political controllability. Is this something so dangerous if used in excess that we should create barriers against using it at all? That is the key question.
The European Central Bank, for example, has constitutional limits prohibiting it. Other central banks don’t have anything formally written down but have deep-rooted resistance; the cultures of the Bank of England and the Federal Reserve are very against it.
The next question becomes: Are you willing to use this tool as a last resort? I would say yes. The negative side effects of running incredibly low and negative interest rates for a long period of time eventually kick in. What I and others propose is that we should ensure monetary finance is only used in extreme circumstances, and in a very tightly disciplined fashion. An independent central bank following an inflation target should determine when it is used.
This is where I differ from some proponents of MMT. They appear to want it to become an everyday part of how you fund public expenditure, hoping it means you can remove the constraints; not just in a crisis environment, but on a permanent basis. I disagree. It should be used as a tool of demand management in specific deflationary circumstances where your rate of nominal GDP growth is sluggish and where the other tools available to central banks have been exhausted.
You have talked about how perversely the actions of central banks have prevented the world weaning itself off a credit boom that had taken place prior to the financial crisis. How do we cure ourselves of this addiction?
If, in 2009, developed nations had agreed to spend the equivalent of three per cent of GDP for three years, financed with money not debt, we would have been in a better place. We would have ended up with less leverage and higher interest rates at an earlier stage. Nominal GDP would have grown faster, partly by getting inflation up to target, but also partly by higher real economic output. We also would have returned to normal interest rates sooner and had less of a public and private debt overhang.
Straight monetary finance does not create a debt contract into the future
Disciplined, one-off monetary finance should be thought of as an alternative to credit finance, because money is not credit. Straight monetary finance does not create a debt contract into the future, it is simply money. We have been terrified of increasing high-powered money on a permanent basis to finance public deficits. And, as a result, we have relied on private credit, but that is an unstable way to stimulate the economy as it creates vulnerability in the future – which is, by the way, exactly what Milton Friedman argued back in 1948.
If, in the current circumstances, we were to run a deficit equivalent to ten per cent of GDP and finance it with monetary finance, it wouldn’t produce excessive inflation. However, if we said, ‘why don’t we run ten per cent deficits and monetary finance them every year for the next 20 years’, this would produce excessive inflation. There is a massive distinction.
Looking ahead to an economic recovery, is there an argument central banks need to normalise monetary policy faster, regardless of the consequences?
Unless inflation is going above target, I don’t think they should. All central bank policy should be contingent on situation and circumstance.
To be clear, I believe in central bank independence and inflation targeting. I just think there are better tools to achieve the end goal. We will end up doing forms of monetary finance anyway, while continuing to deny it. Look at Japan, where despite large fiscal deficits, the central bank buys the debt through QE and continues to pretend these operations are temporary and will be reversed.
Few really believe that in Japan’s case do they?
Very few. Investors and economists know it will never be repaid. But I sometimes worry the only people who do believe it are Japanese consumers, which potentially undermines the whole purpose of the exercise. If Mr and Mrs Watanabe believe this debt has to be repaid, because the government keeps on telling them so, they might think they had better save like mad because there will be future tax increases.
There is a big debate in economics as to whether people act rationally and respond to messages about public debt
There is a big debate in economics as to whether people act rationally and respond to messages about public debt. My view is that it depends. If you bombard them with public warnings from reasonably authoritative sources, telling them they have got this debt that will have to be repaid, maybe Ricardian Equivalence holds.
When the history books are written in 2050, Japan’s debt will never have been sold back to the private sector and it will be transparently obvious this was permanent monetary finance. This will be despite the continual insistence of governors of the Bank of Japan along this 60-year path of monetary finance that they are not doing it. But such is central banking: it is a sort of Wizard of Oz game.
Does the current crisis provide an opportune moment for governments to provide a much-needed upgrade to infrastructure?
Governments’ first priority should be to support consumption because a lot of people have been involuntarily unemployed or furloughed. It therefore makes sense to support people’s incomes. Sadly, it already looks like there will be a lot of people desperately short of money as we come out of lockdown. However, it would also make sense to think about investment. The challenge here is what is known as the ‘shovel-ready’ problem.
Despite investing for the future being the wise thing to do, it takes time to get organised
Faced with this crisis, we should be reinforcing investments in renewable energy and, for example, in fibre-optic networks so people who have learnt how to work at home can continue to work in a more effective fashion. The issue is that these kind of projects cannot be started overnight. Windfarms cannot be built immediately; you need to go through a permitting process, have an auction, decide who the supplier is, and so on. Likewise with roads; they need to go through planning permission. Despite investing for the future being the wise thing to do, it takes time to get organised. So, each time we have a cyclical downturn, we tend to say ‘wouldn’t it be great to stimulate the economy’, and yet five years later we find we didn’t do it.
Governments should try to overcome this by identifying the projects that are shovel ready. At the local government level there will be a need to refurbish properties, and similarly with overdue improvements to hospitals or schools – these could be accelerated to help get the construction sector going as much as possible.
Pubs, restaurants and hospitality businesses face their own unique challenge. Ideally, we should be finding ways of stimulating the economy by redeploying people from those areas. But the challenge is skills. You can’t simply say ‘let’s go and do some more construction to soak up some unemployed bartenders’.
Much of your time at the FSA was spent shoring up the financial system. Do you see any danger the current economic downturn might threaten financial stability once more?
I don’t see another financial crisis as an imminent threat. Although some banks have got bigger – JP Morgan’s assets are the equivalent of a much bigger share of the US economy than in 2008, for instance – that isn’t a fundamental issue. The real question is ‘have they got more capital?’ The answer is yes, they now have plenty of capital.
As Chair of the International Financial Stability Board’s policy committee, I was intimately involved in all the debates about bank capital. We spent a lot of effort between 2009 and 2013 putting in place a new capital regime, Basel III. We did several things: tightened up the definition of what counts as capital, the numerator of the capital ratio; changed the definition of risk-weighted assets, so you couldn’t get away with very low risk weights; increased the required ratio; introduced a counter-cyclical capital buffer and a capital conservation buffer on top of the basic ratio; and implemented a globally-systemic surcharge.
The big global banks at the core of the global banking system now have effective capital ratios that are approximately four or five times higher than they were in 2008. This has put us in a good position and is why, amid this terrible health and economic crisis, I don’t see another financial crisis like 2008 as a huge threat.