In einer bemerkenswerten Rede spricht Adair Turner aktuelle Probleme des Finanzkapitalismus an, und diskutiert mit großer Klarheit geldpolitische Lösungsansätze.
Turner war Chairman der britischen Banken-Regulationsbehörde, der Financial Services Authority. Er bewarb sich 2012 um die Nachfolge von Mervyn King als Governor der Bank of England, es wurde ihm jedoch von der britischen Regierung Mark Carney, der Governor der Bank of Canada, vorgezogen. Turner ist nun Senior Fellow am Institute for New Economic Thinking. Der Investor, Philanthrop und INET-Gründer George Soros hält dies für glücklich, denn nun sei er frei, seine Meinung auszudrücken.
Unverständlicherweise gibt es zu dieser wichtigen Rede bisher nur eine automatische Transkription auf youtube, die manchmal unrichtig und sinnstörend ist.
Für die Leser dieses Blogs – und für mich – folgt hier meine eigene Transkription der Rede. Eine kritische Reflexion der Rede ist einem späteren Blog-Beitrag vorbehalten.
Video von Turner’s Rede auf youtube:
Hier die Slides zu Turner’s Rede.
Ich empfehle, 3 Browser-Fenster für Video, Transcript und Slides parallel zu verwenden.
Introduction by Robert Johnson, Executive Director of INET
„Ladies and Gentlemen,
I believe in every one of our lives,
we can find someone
who helped us
become more than we thought we could be.
When he turned eighty
at his birthday party in London
I was asked to give a speech,
and characteristically on a birthday party
people talk about the gifts
that they want to give
the person celebrating the birthday.
But on that night
I decided to turn things inside out
and celebrate the gift that George Soros gives to all of us
through his example
I have learned more about the value of discomfort
than from any other individual I have ever met.
And I don’t mean by that entirely that he has made me uncomfortable at times.
He has helped propel me to do things
that I had never envisioned trying to achieve;
more I think about his example.
This gentlement who is more than eighty years old
sometimes wears me out
with the intensity
and the drive and the sense of purpose and the sense of urgency that he exhibits
in his business life when we were once partners
but now in his philantropic life.
I don’t know how to share with you
the powerful experience
of seeing George
concerned about the disintegration of Europe.
To me to go on there you remember
whene we were after dinner in Brussels
and we worked
to help George
that there was nothing more he could do.
But he had given so much of himself
and the love in his heart
to the conflict in the society where he grew up
and where he saw
the capacity for pain and evil.
And when George and I began to talk about INET,
what he really impressed upon me at the time of the bailouts,
and the TARP legislation,
and the distrust that was growing in the United States,
is that the stakes were not some simplistic or technocratic
but it’s wheter or not our society
could be resilient in the face of a challenge
to a feeling of trust and order
in the continuation of that society.
As Harold James, on of the scholars who works closely with INET,
has often talked about,
the nineteen thirty one banking crisis in Austria and Germany
created a pressure on the fabric of trust,
on the nerve center of society
that led to as we all know some very very
unfortunate experiences and results,
showing the dark side of human kind
as I try to think of examples in my life and I try to prepare myself
to make a contribution,
I will always remember that summer
I always remember
the deep emotional heartfelt energy
that George gave to Europe,
and the continues to give
in all his endeavours right now.
Ladies and Gentlemen, Gerge Soros.“
Introduction by George Soros, INET founder:
„Well after this introduction
it is my privilege
to introduce another member of our mutual admiration society.
As you have heard from Rob Johnson at lunch time
INET is now entering a new and contructive phase.
The initial task was to show
that the prevailing paradigm
of efficient markets and rational choice
is fundamentally flawed.
I think enough progress
has been made in accomplishing this task
to take on the next one,
which is to produce new insights and new theories.
As Rob Johnson explained
the primary objective of INET is to reform economics
as it is taught in universities,
but perhaps he didn’t emphasize sufficiently
that economic policies
also need to be reformed.
Now we could not have found
a better person
to lead that effort
than our next speaker
Lord Adair Turner.
He was the chairman
of the Financial Services Authority
of the United Kingdom
and he also chaired
the European Financial Stability Institute.
He was a candidate to be the next governor of the Bank of England
but fortunately for us and I believe also for the world
he was not selected.
And this is fortunate for the world
because it frees him up
to speak his mind,
and he has some very original ideas
that we will all benefit from.
I think Adair Turner is the most brilliant and most penetrating mind
preoccupied with the unresolved questions of financial stability and financial regulation.
I know this for a fact
because he was the first financial regulator
who took an active interest
in the theory of reflexivity.
What more convincing evidence could I possilby ask for?
Now I am really very pleased
and very proud
that he agreed
to join INET
as senior research fellow.
If the recent economic crisis is going to produce
some profound new insights
such as John Maynard Keynes did in the nineteen thirtees
he is the one.
Truth be told
I had some aspirations myself,
but I am somewhat old
and I don’t have half his qualifications.
So I am really pleased to hand on
the baton to him.
I am pleased to present Adair Turner.“
Main speech of Adair Turner:
„Thank you George,
Good evening Ladies and Gentlemen.
Thank you George very much.
I am not quite sure what to do after that introduction
first of all I have got to produce a new general theory
in about the next hour and a half.
But I am very glad
becoming a senior fellow of INET,
it’s an arrangement we had made which is going to give me
the freedom both to help INET in all of it’s activities
which I believe are incredible valuable.
I think that before the crisis there was a real failure
of academic economics to address in an effective fashion
the problems which were facing the world,
and that the rebuilding of economics with new thinking
is a vitally important task.
So I am very glad to been given by INET
the support and the freedom both to support their activities
and to pursue areas of personal research,
where I hope to be looking at the integration
between some issues to do with the nature of finance,
the nature of technology,
where jobs are coming from
It’s also a great pleasure to be speaking here at this forth plenary.
We are four years old we were told earlier today by Victor Fung,
we are a bit older than the Fung Institute.
They are still in their terrible two’s
where as we all know who’ve had children,
troubles have tantrums
at two years old,
but hopefully you move beyond whatever tantrums you’ve got.
We are beginning to head into sort of preschool age and hopefully
therefore in a position to make major contributions.
So I am very pleased to be speaking here
at this fourth plenary,
as I have on the three previous occasions.
But I do have three problems or concerns about my speech this evening
to which I have no solution whatsoever.
First I am a bit concerned to be speaking over dinner.
As those of you who have been at the last three plenaries
at Cambridge, Bretton Woods, and Berlin know
I’ve done for three occasions in the past this dinner gig,
and on each of those gigs I’ve been asked to talk on a general subject
on the whole of what was going on at the conference.
And I said to Rob earlier this year
well I’ve done three of those
but I’d like to do something different this year,
because I’d really like the opportunity of presenting a sustained argument.
You know a serious argument an argument with some facts
and some exhibits and slides
and theory and that sort of stuff not
I don’t wanna be just the joke man just not … (inaudible) the light entertainment.
And Rob said ok that’s fine
you’ll be on the agenda to do that,
but what he didn’t tell me is
that I would still be talking over dinner.
So those of you
who after the cocktail
thought that at the end of a long day
another Rob Johnson organized
in which you start working and keep working and keep working
that now is the time to relax and take it easy
well – I am sorry.
You’re gonna have to look at some exhibits,
you have to do some work,
and well – you know – you just have to stick it
My second problem or concern is
that I’m gonna talk about financial stability and monetary economics.
And financial stability in monetary economics is the sort of
intellectual ghetto that I’ve had to inhabit for the last four and a half years
at the FSA in response to the financial crisis.
And I hope at INET conference next year wherever it is
to be able to escape from that ghetto,
and to perhaps talk on some of the wider issues
which we’ve discussed during the day.
I mean, during the day you’ve discussed
the whole future of China,
you’d just a fantastic session on the nature of innovation
and where technological innovation comes from,
and then a fascinating session also on mimetic desire,
the fundamental nature of what we are as human beings.
So I’m not that sad to bring us back
to this technical issue of finance and monetary,
because when you think about it
the area of macroeconomics and financial stability
is not actually addressing the fundamental issues
or fundamental constraints or difficulties in the world,
like resource allocation,
or fundamental opportunities
like innovation and technology,
it is actually basically dealing with the avoidance of negatives.
What fundamentally macroeconomics is about
is making it sure that we don’t screw up,
it’s making sure that we can somehow have enough stability
in the development of nominal GDP and of the price level,
that there is an opportunity for the really important things in economics
which is innovation and human capital and creativity
to express themselves.
So I am at the negative end of today’s agenda,
but that negative aspect of monetary economics and financial stability
is still very important,
because although monetary economics and financial stability issues
is really about the avoidance of self-inflicted wounds –
when we have those self-inflicted wounds
The whole of the 1930s Great Depression was a self-inflicted wound.
As Roosevelt said in his inauguration speech
America was not challenged by some sudden loss of productive capacity
it’s factories were no less productive, it’s workers no less skilled,
but yet it has suffered a terrible, terrible depression.
On a fortunately minor scale what happened in 2007 and 2008 was not driven by any fundamental conflict between social classes
about the distribution of income which is always a difficult issue,
it wasn’t driven by an inability to continue the process of innovation.
It was a self generated failure within the financial system.
It was a totally self inflicted wound.
So although I am afraid I am concentrating this evening
on the negative issues rather than the fundamental issues,
or the positive opportunities of economics,
again I am not apologetic –
I think is an important though limited agenda.
My third problem is something Rob said at lunchtime
in his welcoming remarks.
He said well we call ourselves the Institute for New Economic Thinking,
and he said that places some burden and responsibility with us after a time
to come up with some new economic thoughts.
But – and if I could have my first slide could just come up here –
the problem that I have in that respect
is that I have entitled this evenings presentation (slide 1)
‚Private Debt and Fiat Money:
Lessons from the crisis and from some old economics texts‘
So I feel somewhat worried why am I going back to old economics texts.
Well it’s because despite the need first to think about new thinking
there’s still a lot of wisdom in old economics texts,
and also I think I can defend myself
that going back to old economics texts
is right from the beginning
established as a key INET activity.
Those of you who were at Kings College Cambridge
three years ago in twenty ten at our first plenary
will remember that the very first session,
which was … (inaudible) excellently by Robert Skidelsky
took us back to the relative merits
of Keynes and Hayek,
and many of us noted them with somewhat irony
that the Institure of New Economic Thinking
had begun by thinking
about a set of debates which occured seventy years ago.
But there is still huge wisdom
in old economics texts
and I’m gonna begin today
by referring to some old economics texts and perhaps surprising ones –
because I’m not gonna talk about my great intellectual hero Keynes –
but to some of the founding fathers actually of the Chicago school of ecoomics:
people who supported a very strong clear laissez-faire economics.
Perhaps more laissez-faire in some respects than I would agree with,
but who in particular issues to finance were not laissez-faire at all.
And I’m talking about Henry Simons,
I’m talking about early Milton Friedman,
Milton Friedman in nineteen forty eight,
and I’m talking about Irving Fisher.
And those economist came up with two really quite radical propositions
in their writings in the thirties and forties.
The first was that finance was subject to such potential instability
and that in particular banking was subject to such potential instability,
that not only should we regulate banks tightly,
but that we should regulate banks out of existence.
They didn’t believe that fractional reserve banks should exist.
They believed that we had made a major elementary mistake
in allowing banks to create private money and credit,
that the creation of money was an esential monopoly function of the state,
and therefore they argued for hundred percent reserve banks
in which the monetary base is the money supply.
So that was radical idea number one.
Radical idea number two which is clearly set out in Milton Friedman’s
nineteen forty eight article
is that contrary to the idea
that monetary finance of fiscal deficits should be the ultimate taboo –
written into the constitution of the ECB the worst possible thing you could do the thing that is bound to produce inflation –
we ought not sometimes but always
to finance one hundred percecnt of fiscal deficits with newly-created money.
That is precisely what Milton Friedman argued in nineteen forty eight.
So here you have these Chicago school laissez-faire economists
believers in a free market
believing in one hundred percent reserve banking
and one hundred percent money financing of public deficits.
And I will going to use that set of radical thoughts
to simply explore why did they think that,
and what implications should we draw from that
even if we don’t go all the way in that radical direction.
Because often when you have radical ideas
in economic theory and economic thought,
it’s valuable even if you don’t agree completely with their conclusions
to understand what the argument is,
and perhaps to understand that they are right up to a degree.
So, let me begin with suggesting
in relation to this issue of the role of finance, banking,
and why they ended up in such a radical position
on what banks should be and how we should regulate them,
with suggesting four pre-crisis, pre our latest crisis delusions (slide 2):
Four failures either of economics or of policy.
We assumed we could ignore the details of the financial system –
that’s a statement from Olivier Blanchard the chief economist of the IMF –
we largely created macroeconomic models from which the details of the financial system and the banking system were almost entirely absent.
We assumed that financial activity and financial innovation were axiomatically beneficial because we know that market completion is good
so yet more market completion is even better.
We believed therefore that financial deepening was limitlessly beneficial because again why wouldn’t it be if you believe in market completion
and you believe in laissez-faire economics
everything that the free market does must be beneficial and must be taken as close to a sort of nirvana … (inaudible) Pareto equilibrium.
And finally there I think this is less a failure of a rigorous economics
but a failure of much policy making.
We assumed that credit growth was essential to nominal demand growth
and that we couldn’t drive an economy of growth without accepting
or in some cases deliberately stimulating
a relentless increase in the credit-to-GDP ratio.
Now, those propositions were, I believe, incredibly harmful propositions
and may be proposition which were rejected entirely
by the mid twentieth century economists to which I have referred.
And I think it’s useful to think through why they were so completely
against those assumptions.
First they believed broadly speaking that finance was different,
and I think that is a key insight
that the propositions in favour of free markets
which are pretty good in relations to how to run the restaurant business
break down for a whole set of reasons
which have been explored by many people in the INET community
in relation to finance.
But even more importantly thos mid twentieth century writers
believed that banking was different and that debt was different,
and they believed that we have to understand
three potential drivers –
or at least they focused on two
and then the third one is added by Minsky –
three potential drivers of financial instability which I want to run very quickly through (slide 3).
debt contracts create specific risks.
Debt is different from equity,
and the more debt contracts we have in our economies,
the more we have potential for instability.
unregulated bank credit and private money creation is inherently
subject to instability
and unless tightly regulated will run out of control.
and this is where Minsky comes in because this is not really
in the writings of Fisher or Simons,
lending secured against real estate or against any asset which can rise in value as you extend more credit is deeply pro-cyclical.
From which it follows that real economy leveraged credit
and credit creation dynamics,
and credit asset prices cycles are crucial macroeconomic variables and phenomena,
and variables and phenomena which we ignored
and overtly stated that we could ignore in the pre-crisis period.
Let me run very quickly through
the arguments in favour of those three propositions.
First of all debt contracts in general.
I think one can identify three reasons why debt contracts are different
from equity contracts (slide 4).
The first is
the tendency for myopia or what Andrei Shleifer has called local thinking.
When you hold an equity contract you see the value of that going up and down every day.
You know that you hold something which has risk in it.
The difficulty with a debt contract is that if you think about the frequency distribution of returns,
it has a significant probability that you will get all your money back,
and then a tail of the probability where you lose.
But in the good times that tail is not observed.
So as Shleifer has said
you’re subject to local thinking:
a strong tendency in the good times for people to assume
that inherently risky debt contracts
And therefore to be willing
to extend those in excessive quantities.
And Shleifer has made the point that in the pre-crisis period
there were many debt securities
that in his phrase
‚owed their very existence to neglected risk‘.
And there was a totality of debt contracts across the economy
which is larger that could possibly be supported
by the objective risks which existed
at the level of the pre-debt servicing
operating risks of the economy.
And that creates the possibility of multiple equilibrium.
And you want an example of multiple equilibria,
think about Greek debt.
Two thousand and six
Greek debt is trading
at about thirty basis points higher
than German bunds.
And people are queuing up to lend the Greek government debt,
because they have fallen into that local thinking
where they are no longer doing the objective analysis
of the underlying risk.
So debt in inself
is subject to local thinking,
volatility of credit assessment:
first unreasonably optimistic and then swinging to extreme and the denial of … (inaudible) to extend new credit,
and multiple equilibria.
when debt goes wrong it goes wrong in a non-smooth crunchy fashion.
When you hold the debt equity instruments and you lose money,
you lose money gradually,
you know that you could lose money,
and the system can absorb that.
Debt contracts go through processes of default,
and default is a denial of a complete market system.
Ben Bernanke in his essay on non-monetary feaures of the Great Depression –
of the banking crisis – has this great phrase that in a complete markets world
bankruptcy would never be observed.
There would be a smooth adjustment of the value of the debt contract
as you approached bankruptcy.
But in fact, in the real world we see bankruptcy, we see default,
we see those non-smooth adjustment processes.
And then the third difference is
the need for continual roll-over,
because debt contracts have a specific term,
they continue to come to an end,
the economy needs them to be continually rolled over.
Victor Fung earlier today talked about what happened to trade
in 2008 when trade finance got cut back
a sudden shock to the real economy.
There is a real distinction here between equity and debt.
You could image an economy in which new equity issues was zero for five years
and which still functioned,
there would still be a process
because the equity investment that you’ve given in the first place
But because debt has to be continually recyled because it is not perpetual,
the process of new credit provision
is fundamental to the macro economy,
and when it gets interrupted
severe bad things happen.
So first, debt contracts are different. They create specific risks,
Secondly, banks are different.
And I think this is a crucial insight that we often miss,
but which Fisher, Simons, and Friedman really focused on.
It is often said in general text books or discussions what the banks do,
and you often hear descriptions where they take deposits
and they intermediate it to to investment.
This is a lousy description of what banks do.
The idea that banks intermediate
a pre-existing set of liquid asset savings
Banks simultaneously create new private credit and new money.
They do that because they have a maturity transformation function and the fact that they do it is a fundamental macroeconomic variable of vital importance to the dynamics of nominal demand growth.
And it is crucial that we understand,
as Simons and Fisher and Friedman did,
And then thirdly,
lending secured against real assets which can rise in value (slide 5) is inherently subject to the sort of cycles which Hyman Minsky described
in which increased credit extended
– increases asset prices,
– produces expectations of future asset price increases,
– produces increased borrower demand for credit,
but simultaneously produces
– low credit losses,
– high bank profits,
– confidence reinforced,
– increased bank capital basis,
– favorable assessments of credit risks,
– and increased lender supply of credit.
That process is inherent
to why credit is provided in such a strongly pro-cyclical fashion,
over provided in the upswing,
and then under provided in the down swing,
as all those elements go into reverse.
Now the implication of all that,
debt is different,
banks are different,
lending against secure assets is different,
is that the size of the banking sector,
the amount of real economy leverage,
and the amount of money being put against real assets and asset price cycles,
these are fundamentally important economic variables
but variables which we largely ignored in the pre-crisis period.
And we sat for many years
watching or rather not watching
what we should have been watching,
dramatic changes in the size of these variables across our economy
what a large effect they must be having on the degree of financial instability.
So that for instance (slide 7) if you look at –
this is headed ‚The growth of the financial sector‘
it ought to be the growth of the real economy and financial sector leverage –
if you look at the UK on the top and the US at the bottom
you will see over the last twenty years in the UK
significant increases in corporate leverage,
in household leverage but also included interestingly
in financial sector leverage,
which is the scale of the financial sector lending money to itself.
On the longer time series on the US,
look at that extraordinary impacts of the deleveraging
of the nineteen twenty nine,
and then the huge leveraging up of the economy not just over thirty years,
but over a sixty year period.
We now have compared with
the nineteen fifties or sixties or forties
a massively more leveraged economy
with massively large financial and in particular banking sectors.
Because what we have seen (slide 8)
is that process of simultaneous bank credit and money creation.
You can see here for the last fifty years in the UK
household credit as a percentage of GDP
has gone from fifteen to eighty percenct of GDP –
that’s a transformation in the scale of credit,
and you can see on the red line here
the somewhat matching increase in deposits.
Because broadly speaking in a total closed economy
the credit is balanced by the deposits,
it isn’t in this picture because the ability of the UK
to run current account deficits and borrow wholesale money from overseas.
What we also saw again (slide 9) –
and again these are the figures of the UK economy –
is major changes in where credit was going.
The orange area on the top there
is the increase in commercial real estate lending.
No further increase you notice
in the UK or in the US
in non-commercial real estate PNFC lending,
so lending to non-commercial real estate companies
not going up as percentage of GDP,
but dramatic increases
in real estate.
so we have sat
through varying significant increases in the scale of the banking system
in the amount of leverage in the real economy,
the balance between debt contracts and equity contracts,
and with an increase in percentage of that
supporting a real asset
which is capable of entering an asset and credit cycle such as Minsky described.
And finally – I want to show the charts on this –
in addition to that occuring within the banking sector,
we saw the development before the crisis of the shadow banking sector
which is essentially a mechanism of .. (inaudible)
outside of formal bank regulation
the precise economic equivalent
of bank credit and quasi money creation.
So we had I am suggesting
four pre-crisis delusions (slide 11)
and those delusions led us to be largely indifferent and blind
to very major changes in the leverage in our economy
and the financial risks within our economy.
And in particular they made us blind –
on the fourth line there –
to the growth of credit as a percentage of GDP.
We developed a thesis
in some cases that we needed credit growth to grow faster than GDP
to maintain adequated demand,
certainly than if it kept on growing faster than GDP
there was nothing wrong with that
so there was no limit,
we didn’t have to pay attention to the stock figures
I think that is a major mistake,
and I think a lot of good economic research is now going to challenge that.
If you look at the work of Alan Taylor and Moritz Schularick
who are recipients actually of INT grants,
they have been looking at the increase of credit
which is therefore an increase in financial intensity –
financial deepening you might call it –
and concluded that financial deepening at least in the developed economies
over the last thirty fourty years
has at very least not provided any beneficial impact on growth.
But more seriously I think we are beginning to see the emergence
of hypothesis for instance suggested by this work (slide 12)
which comes out of the BIS –
a study by Steve Chechetti and Enisse Kharroubi –
which are suggesting that if you look at the relationship between credit and GDP,
then maybe an inverse U-function,
that up to a certain point
the creation of the banking system,
the provision of credit,
is positive for growth.
But there you can reach levels of credit-to-GDP
which are negative.
Now what is interesting is
that wouldn’t at all have surprised
those mid twentieth century economists (slide 13),
because they believed –
as it says here Henry Simons in his famous article ‚Rules versus Authority‘ –
that in the very nature of the system
banks will flood the economy
with money substitutes during booms and precipitate futile effects
at general liquidation afterwards.
They believed that 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.
Now, in that phrase Simons in focusing
on the money side of the bank balance sheet,
but always remember the money side of the bank balance sheet
is just the flip side of the credit side of the bank balance sheet.
So, from both points of view
the hypothesis is
that you can create too much credit and too much private money.
Why did Simons and Fisher in particular writing in the thirtees believe that?
But of course they believed it because they were the inheritors of the crash of twenty nine,
and they were trying to understand what it had gone wrong
in that huge creation of credit
as a percentage of GDP
in the nineteen twenties.
And they ended up as a result
ending up with a very radical position.
They believed that it was so clear
that credit could be created
to excess and money created to excess
that they ended up believing that we shouldn’t have
fractional reserve banks at all.
They wanted hundred percent reserve banking,
so every deposit would be backed by a central bank reserve,
the monetary base would be the money supply,
the only money would be in … (inaudible) terms outside money,
there would be no inside money created privately by the financial system.
Now, I think they were too radical.
I think there is an argument for fractional reserve banks up to a point (slide 14).
I think there are reasonable arguments put forward for instance by Walter Bagehot in ‚Lombard Street‘
that the existence of fractional reserve banks
performing a maturity transformation function
may facilitate the mobilization of savings and investment
which might otherwise not occur.
I think it is also the case
that fractional reserve banks facilitate
welfare enhancing smoothing of consumption across the cycle,
and I think that that can be a welfare optimal function
even if it has no positive effects on growth.
I therefore think
that actually abolishing fractional reserve banks –
as has been proposed recently by a number of people,
Michael Kumhof for instance, Larry Kotlikoff,
in the last few years –
I think it is too radical.
But I do think that when you think about the arguments
I mean when you think about the fundamental nature
of the risks that debt creates,
although I wouldn’t go as far as fractional reserve banks –
I think these arguments provided good argument for dramatically increasing
the fraction of liquid reserves and the fraction of capital resources.
Because once you’ve thought about those arguments
about what private money and credit is
and what debt contracts do,
I think you realize that the regulation of the amount
of private money creation and of private credit creation
is a crucial function,
and that through our capital and liquidity regulation
we are essentially controlling the amount
of that credit and money creation.
And that is why from a macro point of view –
not just from a micro corporate finance point of view –
but from a macro point of view
I am certainly attracted to the idea
that if one were a benevolent dictator of a greenfield economy,
which is of course what everybody in this room dreams of being,
and unconstrained by transition problems,
one would set capital ratios of banks not of the sort of
seven percent risk weighted ratios to which we manage to creep them up
in the basel three reforms,
but more twenty-five or thirty percent or something like that.
I think we are the inheritors.
I have felt for the last four and a half years as a financial regulator
as the inheritor of a fifty to one hundred year mistake
in which we have allowed
the banking system to run with far too low fractions of capital and liquid assets.
And i further believe
that we have got to identify
the total level of debt within our economy,
that overall balance between debt and equity contracts
as a crucial determinant of instability,
and therefore if necessary focus on it –
not only through the mechanisms of banking regulation –
but also through the direct regulation
of the amount of loans out there in the economy,
for instance through loan-to-value ratio or loan-to-income ratio limits.
Now of course or other constraints on the total amount of credit extended
against real assets.
Now of course that doesn’t always make you popular
Norman Chan was just telling me over drinks
that his latest operations to slow down the Hongkong property market
had made him a bit of a hate figure
among the thirty thousand real estate agents here in Hongkong.
But I think we do have increasingly have to treat
the total amount of debt as a crucial variable,
and that therefore suggests (slide 15)
the first great insights of those early laissze faire writers.
Finance is different,
debt is different,
banking is even more different,
and the arguments from laissez-faire which are strong in some other sectors of the economy
are simply not applicable.
But the second thing which those mid twentieth century laissez-faire economists believed
was that monetary and financial stability are very closely interlinked concepts,
and that I think was the other thing that we missed in the pre-crisis period.
The implication of what i have said before –
one implication is that we mustn’t let leverage get to excess levels.
The best thing is not to allow leverage to get to an excess levels in the first place.
But, and that’s because it tends to produce a crisis
and because when you go through the crisis
you then enter an immenseley difficult macroeconomic phase
of private sector deleveraging
and potential deflation.
But once you are in that position
you got to deal with that position
and you got to have macroeconomic policies to deal with that position.
Once you go through a crisis (slide 16)
which follows many years of lending growth above GDP
when by definition
debt-to-GDP is a stock ratio is gonna go up
and you can see that over many years
where lending to UK businesses is well ahead of nominal rates.
When you have a financial crisis
and you enter this phase
you then end up
with very low credit growth.
Now that is partly
because your financial system is impaired
and credit supply is impaired,
but it is also because the credit demand simply isn’t there.
And i think
one person who has described
better than anybody else why that occured
is Richard Koo who is seated over there
within his concept of understanding what has happened in Japan
as a balance sheet recession.
When you end up with too much credit,
too high levels of leverage,
and you go through a crisis,
you enter a period in which either corporates or households –
it depends on which sector of the economy is over leveraged –
are determined to get their balance sheets back into balance,
and who therefore become pretty much totally inelastic
to anything which you can do
with the intererst rate.
So that if you look at Japan (slide 17)
you see in the red line
the reduction in the policy rate in the early to mid nineteen ninetees
effectively to zero,
but you see credit growth essentially negative or zero as well.
Because what is going on in that environment again in the red line here (slide 18)
is that the private non-financial corporations in Japan
are running a continual financial surplus to get their balance sheets back in balance,
and they are imposing a deflationary deleveraging effect on the economy.
In that environment as Richard (Koo) I think has persuasively argued
the government has to run a large fiscal deficit,
which you can see in the blue line there,
because without that you have a deficiency of nominal demand.
But the problem with them running that deficit
is the stock effect (slide 19).
The stock effect in the blue line there
is general government debt-to-GDP in Japan
going up from sixty percent in nineteen ninety
to over two hundred percent today.
Because what you enter is an environment
where the private sector attempt to delever
works in the private sector,
but it simply shifts leverage
to the public sector of the economy.
So that for every percentage point you see on the red line there the corporate sector,
there is two or three percentage points increase in the fiscal deficit, in the fiscal debt-to-GDP.
That’s the pattern we have seen in Japan for the last twenty years,
and it is the post crisis pattern in the UK, the US, and Spain.
In each of those I hope you can see (slide 20) what you have is the private sector attempting to and beginning to achieve a small amount of deleveraging,
But you have a shift of that leverage over to the public sector of the economy.
This creates a major problem,
a major danger of deflation,
as indeed in the nineteen thirtees.
And you therefore have a major issue for macro policy.
In this environment, how do you maintain adequate nominal demand,
and therefore a reasonable combination of real output growth and price stability as defined in the way that I think it ought to be defined,
as low but positive inflation rates.
On that issue, should we here consider also the radicalism
of Simons, Fisher, and Friedman in forty-eight.
Because what they said was ‚Fund fiscal deficits with money finance‘.
Well to think clearly about that issue
I think we need a framework of how the levers of macro policy
relate to the effects, and I like to suggest this framework (slide 21),
which I suggest is important to think straight on this issue.
At the middle of the framework in the red box is aggregate nominal demand
which is nominal GDP.
That is really the fulcrum of macroeconomics what determines
and what are the implications
of the rates of growth
of nominal GDP.
On the right hand side you have the simple mathematics
that an increase in nominal GDP can either be
an increase in prices or an increase in real output,
and therefore also that is true in total and it’s also true at the marginal level.
When you increase nominal GDP you might increase the price level
or you might increase real output.
So those are the effects.
On the lever side, there are a set of policies which might influence nominal GDP. Those include fiscal policy, deficits and surpluses, monetary policy, interest rates, QE, forward guidance, central bank private credit support, such as US credit easing or the UK’s finance funding for lending scheme, and also macroprudential policy, the level which the regulators set in terms of the capital or the liquidity requirements of banks.
Now, those are the classic levers, and what I want to discuss among other things is one extra lever which I am going to call O.P.M.F (slide 22),
which stands for Overt Permanent Money Finance.
Overt Permanent Money Finance, sometimes later qualified Overt Money Finance (OMF) – but it has to be permanent to be effective – is essentially a combination of the fiscal and monetary levers.
It’s running a fiscal deficit which you finance with central bank money.
So that’s my framework – effects and levers.
And I would like to make two points about that framework.
The first I want to assert something which I call the independence hypothesis which I think is important
and that is that I want to assert that the division of any increase in aggregate nominal demand between prices and real output
is not determined by the lever that you pulled,
but by a set of real economic characteristics
such as the level of spare capacity in the economy, in capital or physical capital,
or the flexibility of price setting processes in labour or product markets.
Basically if there is spare capacity,
and if there are flexible price setting processes,
a large amount of that aggregate nominal demand will go into real output.
But if you are at full capacity utilization,
or if you have inflexible price setting processes,
a large amount might go into prices.
But broadly speaking (slide 24),
the division of the aggregate nominal demand increase
between prices and real output
is independent of the lever,
the tools that you pulled to affect aggregate nominal demand.
Now the reason that is important is that a lot of debates about what we do in the present deflationary period are bedeviled by random non-independence assumptions which are not well specified.
You get people who simultaneously say ‚You can’t run a fiscal deficit and print money because it would be inflationary‘
but they say ‚We go to reduce the capital requirements on banks
in order to extend credit to the economy
because that will get the economy going.
Now what they are assuming there
is that they’ve got one mechanism in increasing aggregate nominal demand which is necessarily going to have a price effect,
and than another is necessarily gonna have a real output effect.
But my assertion is it’s not believe that determines that,
it’s those real factors on the right hand side.
That’s my first assertion about this framework.
My second is that the one problem in economics
to which there is always a solution
is inadequate aggregate nominal demand.
I don’t know of any other problems in economics to which there are always solutions,
but what I mean by that is if we face absolute deflation
which is both falling output
and falling prices –
so we definitively know
it would be good to have more aggregate nominal demand –
there is always a solution
and that if we fail to take that solution
we should really be condemned for having failed to be imaginetively enough.
But not at all that imaginatively because it simply requires doing what Milton Friedman and John Maynard Keynes both said we should do.
Milton Friedman said ’spread helicopter money around‘,
John Maynard Keynes said ‚put banknotes in bottles in disused coalmines –
a bit odd that relatioship because Keynes was not normally the puritan
who demanded that you work for your efforts – he was a believer in the good life – but essentially the same proposition.
At the limit we can always increase aggregate nominal demand.
Let me make one final point on this framework:
I suggested an indepence hypothesis,
but I also recognize that you can challenge that independence hypothesis.
You could suggest that there are links (slide 25) which directly link
something on the left to something on the right.
For instance if it is believed wrongly or rightly by the market
that either fiscal policy or monetary policy or permanent monetary finance
will tend to have an inflationary effect,
we have to be somewhat alive to the danger that
that in itself might become self-fulfilling.
So it is possible to define an expectation channel
where that particular form of stimulus does have more of a price
and less of an output effect.
It might also be possible to convince ourselves that we are clever enough to define some left hand side levers which would simultaneously increase aggregate nominal demand and the capacity of the economy –
for instance by infrastructural capacity and investment –
in which case you might say you can do something which would skew the results to real output.
But the crucial thing I do argue is that whatever non-independence hypothesis you are making you must specify what it is,
and you mustn’t simply leap to your favorite policy response
by assuming that it will tend to have more of a price or more of a real output effect,
without specifying why you are breaking away from indpendence.
So that’s my framework.
Let me as quickly as possible now talk about the different ways that we could stimulate aggregate nominal demand.
We could do it (slide 26) through the three boxes shaded darker on the right hand side,
through a combination of things in the monetary policy,
central bank credit support,
and macroprudential space
and broadly speaking this is the policy being pursued in the UK and the US at the moment.
We are doing things like (slide 27)
standard quantitative easing buying government bonds,
wider quantitative easing buying private bonds, equity, property, FX,
as did Japan at the moment,
liquidity support in the European environment through LTRO,
direct credit subsidy in the UK through ‚Funding for Lending‘,
some degree of forbearance in terms of the pace of which we would otherwise increase capital and liquidity standards to acceptable levels.
That is certainly the UK policy mix at the moment,
fiscal austerity supposedly offset by this combination of monetary and macroprudential levers.
And let me make it plain that several of these levers I have directly supported
in my own role within the UK policy environment,
and if I had in addition been on the monetary policy committee,
I would have also argued for the level of QE which we have in the UK.
So I am not against these levers,
but I do believe that we have to be aware that these levers may be subject
both to diminishing marginal effectiveness and to adverse side effects.
Why might they be subject to potential limitations (slide 28)?
Well – it’s crucially important to realize that these levers work through indirect channels.
They essentially stimulate credit growth or seek to.
They seek to stimulate asset price increases and a search for yield.
And it is possible those are limited.
First of all if borrowser are – as Richard Koo has suggested – totally focused on strengthening balance sheets,
then the extension of QE to the long run of the yield curve may bring down long term rates as well as the policy rates,
but you may still not get a credit amount response.
Long as well as short term interest rates may approach the ZLB (zero lower bound).
As for adverse side effects, this policy commits us to low interest rates over many years, or in Japan – decades.
It is essentially trying to work through a stimulus to private leverage
and that’s a slightly odd thing to do.
This is the hangover cure which is another drink,
or the hair of the dog that bit you.
Relaxed prudential standards are bound to produce future financial stability risks,
exchange rates spillover effects might be significant,
and then there are also distributional effects.
These policies tend to be very good for asset owners at the top end of the income distribution, and less good for other people.
So I am concerned that this policy mix relying entirely on monetary and macroprudential levers is subject both to diminishing marginal returns
and to adverse side effects.
So the alternative – the classic alternative – is funded fiscal stimulus (slide 29).
You run a budget deficit and if it isn’t sufficient you run a larger budget deficit.
And the great benefit of that of course is you’re either cutting someones taxes, you’re increasing expenditure,
you are putting money directly into someones pocket.
As Milton Friedman said in his 1948 article „you’re doing something which directly goes into the income stream“.
You are not working through this complicated portfolio asset balance effects. You are directly impacting the income stream.
But beyond that against those mechaisms,
funded fiscal stimulus
has always been twofold.
First of all that you wouldn’t use a crowding out effect whereby you simply increase interest rates,
because you are borrowing more money to fund this fiscal deficits.
Or you produce a Ricardian equivalence effects,
because the person who is getting the benefit of those tax cut knows that they’ll have to pay for it in ten or fifteen years time
by servicing the debt which has been called up.
Now in relation to the first of those,
the crowding out effect (slide 30),
I think Brad DeLong and Larry Summers in a recent important article
have put forward a very important counterpoint of view,
and they have argued that when interest rates are contrained by the zero lower bound,
discreational fiscal policy can be highly efficacious as a stabilization tool,
indeed under plausible assumptions it could actually improve long-term debt sustainability.
And the core of their argument
is that the fiscal multiplier –
which is in low in normal times,
because the bigger the debt you run
the higher the central bank would put the policy interest rate,
but that’s not true in current times that we face,
because the central bank is committed
to keeping interest rates at the ZLB – the zero lower bound –
for the foreseeable future.
So they basically say,
if you’ve already got a Ben Bernanke who said I’m keeping interest rates low to twenty fifteen,
the crowding out effect of higher fiscal deficits
simply is not there.
And I think that is fairly compelling,
but it still leaves the Ricardian equivalence effect,
it still leaves the problem of
‚What you’re gonna do if with large fiscal deficits
you have a relentless increase in debt-to-GDP (slide 31),
such as we have had in Japan?‘
The headline level, the top level, the red line,
going over two hundred percent of GDP,
over a hundred fifty percent of GDP even when you take out the holdings of the Bank of Japan,
and a hundred percent even when you take out the holdings of the commercial banks.
What do you do about the fact
that funded fiscal stimulus can produce the relentless rise in government debt?
And I will do something I never would normally do in a speech,
I am gonna to make a prediction,
a market prediction:
Japanese government debt is not going to be repaid in the normal sense of the word repaid.
If we mean by repaid that Japan having run large fiscal deficits,
is at some stage going to run surpluses sufficient to pay down this debt,
forget it, it is not going to occur.
This debt is either going to be monetized or restructured at some stage,
is going to be offset by a high level of inflation which essentially means that people will abort this debt at a negative real interest rate.
It will not be repaid in the normal sense of word.
So what do you to if you’re in that situation?
What Ben Bernanke said (slide 32) in two thousand and three was
that you do a money financed tax cut.
He argued quite overtly then for a tax cut for households and businesses that is explicitely coupled with incremental purchases of BoJ (Bank of Japan) purchases of government debt,
so that the tax cut is effectively financed by money creation
He said it was important to be clear that much or all of the increase in the money stock arising from that is viewed as permanent,
he said the good news is that consumers and businesses will spend that tax cut,
since it is a tax cut which creates no current or future debt servicing burden –
don’t worry about Ricardian equivalence even if they were that sort of consumers who wonder each day of the week about Ricardian equivalence –
and he said the debt-to-GDP ratio will fall because there is no increase in nominal debt,
but nominal GDP would rise owing to increased nominal spending,
and he said ‚I am proposing this for a tax cut, but you could use exactly the same argument to support increased spending programs to facilitate industrial restructure.‘
That’s what Ben Bernanke argued in two thousand and three.
He argued that you just do it in special circumstances.
Interestingly (slide 33), Henry Simons and Milton Friedman argued you should do it as a perfectly normal procedure in all times.
Milton Friedman on the right:
„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 …“
Money is simply a non-interest bearing government security.
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.
And Henry Simons argued exactly the same.
Now, there is an important wrinkle here,
it was much easier for them to argue that,
having already argued for a hundred percent reserve banking,
because they’ve created an environment in which the monetary base is the monetary supply.
But even when we are not in that world even when we have fractional reserve banks,
I think there is still an argument under some circumstances
for overt money finance.
I think it’s advantage over monetary credit support and macro stumulus (slide 34) is it works directly,
rather than by a set of indirect levers,
and it’s advantage versus funded fiscal stimulus is that it clearly is not subject either to crowding out or to Ricardian equivalence effects.
But isn’t it inflationary?
Isn’t money finance of public deficits inflationary (slide 35)?
Well if you go back to my independence hypothesis
though, if you’re in an environment where you want to stimulate aggregate nominal demand,
and if you don’t want to stimulate aggregate nominal demand,
you shouldn’t be talking about all those other mechnisms
by which we might stimulate aggregate nominal demand.
Your prior first step is to work out:
do you want to stimulate aggregate nominal demand,
and if you do, we should then look to all the levers available.
So why are we so terrified of money finance of fiscal deficits?
Well there is a very, very good reason.
Technically, overt money finance of fiscal deficits
is no more inflationary then any other way that we stimulate nominal demand,
and like all other ways
it’s impact on inflation will depend upon the amount that you do.
You do a billion dollars you’ll have a very small amount,
if you do ten trillion,
you’ll produce hyperinflation.
It’s simply a spectrum like most things in economics.
But the argument against it,
is that it isn’t a spectrum,
but as you’ve let the cat out of the bag,
because you’ve broken a taboo.
The arguments against overt money finance –
and again, Friedman said it in forty eight,
is that this proposal (slide 36) has of course dangers,
explicit control of the quantity of money by the governement
and the explicit creation of money to support actual government expenditures
may establish a climate favourable to irresponsibel government action and to inflation.
The difficulty here is not a technical problem,
it’s a political economy problem.
Once having admitted
and revealed to the population and politicians
that this is technical possible,
how to we make show that we do it
in the small number of years out of each century
where I would argue it’s appropriate
and in the quantity that is appropriate
rather than all the time,
and in an appropriate amount.
OMF carries political economy risks,
that is why
overt money finance has in central banking and in economics
a close to taboo status.
And taboos –
I think we very probably quite close to this in that session
in mimetic synchronous systems this afternoon,
taboos have valuable roles within human society.
if you’ve got a powerful potential mechanism,
you should have the confidence to take it out of the taboo box,
and I believe it is proper applicable
for us to use it,
and to use it in responsible amounts.
Now I think it is possible to locate it
within the same discipline of central bank independence,
in pursuit either of inflation targets
or in nominal GDP targets,
with which we have constrained the use
of all policy levers.
But it is because it’s such a taboo subject,
that even when highly respected economists propose it,
they don’t actually
call it that.
So I think of overt money finance (slide 37)
as a sort of policy that dare not speak it‘ name.
If you look at the highly erudite speech which Michael Woodford –
one of the great can0ns of New Keynesian monetary eoncomics –
gave at Jackson Hole last August:
he talked about the fact that optimal policy now requires
„Policy action that would stimulate spending immediately, without relying too much on expectational or indirect channels.“
He said the most obvious source of the boost to aggregate demand
which would not depend on expectational channels
is an increased fiscal stimulus,
and then he said,
„You need to be clear that having funded that with money,“
which is what he described:
„the increase in the base money is intended to be permanent.“
Now put that together,
and that’s pretty much what Ben Bernanke said,
that is overt money finance.
But he doesn’t quite call it that,
because we have a taboo against it.
I think we need to be able to break a taboo,
I think that taboo just did got broken in Japan earlier today,
by the interventions of Mr. Kuroda.
So I want to end with two thoughts (slide 38)
What I’m really saying by four major economic currency zones:
One, for Japan Bernanke was right.
Japan has been absolutely right as Richard Koo has suggested to run large fiscal deficits,
but those fiscal deficits will not be serviced
in the normal sense of the deficit turning into a surplus.
They need to be montized.
If they had started to monetization ten years ago,
Japan would have been in a better state today.
It has left it so late,
that there are some dangers that ther’s so much debt out there,
that the process of monetizing it could get out of control,
but Bernanke was certaily right in two thousand three.
In the US,
you could argue that the policy mix is damn close to overt money finance.
Ben Bernanke keeps on signalling
to the fiscal authority that they should be happy
to run large fiscal deficits,
and making it plain that he will monetize them if necessary,
in which case why scare the horses by telling them what’s going on,
if we’re roughly doing the right stuff in any case.
In the Eurozone,
optimal policy is blocked by incomplete currency union.
It’s damn difficult to agree to monetize financial debt,
when monetizing it in the Eurozone,
would be like the Fed buying State of California debt or State of Illinois debt,
not federal debt.
But that’s what Spanish debt and Italian debt are,
they are the functional equivalent of State of Calfornia and State of Illinois,
so a whole load of distributional and discipline issues get in the way of optimal policy.
In the UK –
actually that’s the area where I am least convinced
that we are absolutely certain we need more nominal demand –
because the odd think for the UK for the last four years,
is that eighty percent of all our increase in nominal GDP has gone into a price effect rather than a real output effect.
So I am little bit weary in the UK
of simply believing we need more nominal demand.
But to finish,
although I am setting out those four possibilities of policy there,
actually my main purpose tonight is not to suggest these specific policies,
but to draw this lessons from those earlier writers.
financial stability and monetary policy issues are closely linked
in a way which we dangerously ignored before the crisis.
we need to understand,
that debt contracts are different,
banks are different,
credit and asset price cycles are different,
and therefore the level of leverage within the economy,
the pace of growth of leverage,
these are crucial macroeconomic variables.
The economy, the monetary system is not neutral to the financial system,
and we have got to have specific policies to focus on it,
and to contain the level of leverage.
if you don’t do that in advance
you end up with excess levels of leverage which produce financial crisis,
and that financial crisis tips you into an extremely difficult deflationary and deleveraging period,
in which you’ve got to be innovative and creative and open-minded
about the policy levers available to pull you out of that situation.
So that is my hypothesis,
and I now look forward to hearing the various ways in which Bill white and Hiroshi Watanabe are going to disagree with me.
Thank you very much indeed.