Mar 11th 2016

Are Central Banks Really Out of Ammunition?

by Adair Turner

 

Adair Turner, Chair of the Energy Transitions Commission, was Chair of the UK Financial Services Authority from 2008 to 2013. He is the author of many books, including Between Debt and the Devil.

LONDON – The global economy faces a chronic problem of deficient nominal demand. Japan is suffering near-zero growth and minimal inflation. Eurozone inflation has again turned negative, and British inflation is zero and economic growth is slowing. The US economy is slightly more robust, although even there recovery from the 2008 financial crisis remains disappointingly slow, employment rates are well below 2007 levels, and annual inflation will not reach the Federal Reserve’s 2% target for several years.

But the debate about which policies could boost demand remains inadequate, evasive, and confused. In Shanghai, the G-20 foreign ministers committed to use all available tools – structural, monetary, and fiscal – to boost growth rates and prevent deflation. But many of the key players are keener to point out what they can’t do than what they can.

Central banks frequently stress the limits of their powers, and bemoan lack of government progress toward “structural reform” – a catch-all phrase covering trade liberalization, labor- and product-market reforms, and measures to address medium-term fiscal challenges, such as pension age increases. But while some of these might increase potential growth over the long term, almost none can make any difference in growth or inflation rates over the next 1-3 years.

Indeed, some structural reforms, such as increasing labor-market flexibility (by, say, making it easier to dismiss workers), can initially have a negative effect on consumer confidence and spending. Vague references to “structural reform” should ideally be banned, with everyone forced to specify which particular reforms they are talking about and the timetable for any benefits that are achieved.

If the core problem is inadequate global demand, only monetary or fiscal policy can solve it. But central bankers are right to stress the limits of what monetary policy alone can achieve.

The Bank of Japan recently introduced negative interest rates, and next week the European Central Bank will probably take its own rate still further into negative territory or launch yet more quantitative easing (QE). But these levers can make little difference to real economic consumption and investment.

Negative interest rates are intended to spur credit demand among companies and households. But if banks are unwilling to impose negative rates on depositors, the actual and perverse consequence could be higher lending rates as banks attempt to maintain margins in the face of the running losses they now make on their central bank reserves.

As Mark Carney, Governor of the Bank of England, has noted, negative interest rates should be used only in ways that stimulate overall global demand, rather than simply to move demand from one country to another via competitive devaluation. But achieving such stimulus via negative interest rates may be impossible. The potential for yet more QE to change behavior in the real economy is equally unclear.

This means that nominal demand will rise only if governments deploy fiscal policy to reduce taxes or increase public expenditure – thereby, in Milton Friedman’s phrase, putting new demand directly “into the income stream.” But the world is full of governments that feel unable to do this.

Japan’s finance ministry is convinced that it must reduce its large fiscal deficit by hiking the sales tax in April 2017. Eurozone rules mean that many member countries are committed to reducing their deficits. British Chancellor of the Exchequer George Osborne is also determined to reduce, not increase, his country’s deficit.

The standard official mantra has therefore become that countries that still have “fiscal space” should use it. But there are no grounds for believing the most obvious candidates – such as Germany – will actually do anything. And there is no certainty that even if all the countries that have fiscal space used it, the boost to global demand would be sufficient.

These impasses have fueled growing fear that we are “out of ammunition” to fight inadequate growth and potential deflation. But if our problem is inadequate nominal demand, there is one policy that will always work. If governments run larger fiscal deficits and finance this not with interest-bearing debt but with central-bank money – nominal demand will undoubtedly increase, producing some mix of higher inflation and higher real output.

The option of so-called “helicopter money” is therefore increasingly discussed. But the debate about it is riddled with confusions.

It is often claimed that monetizing fiscal deficits would commit central banks to keeping interest rates low forever, an approach that is bound to produce excessive inflation. It is simultaneously argued (sometimes even by the same people) that monetary financing would not stimulate demand because people will fear a future “inflation tax.”

Both assertions cannot be true; in reality, neither is. Very small money-financed deficits would produce only a minimal impact on nominal demand: very large ones would produce harmfully high inflation. Somewhere in the middle there is an optimal policy – a common-sense proposition that is often missing from the debate.

Amid the confusion, the one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible. If political irresponsibility is inevitable, we really are out of ammunition that we can use without blowing ourselves up. But if, as I believe, the discipline problem can be solved, we need to start formulating the right rules and distribution of responsibilities.

One thing is certain: Relying on structural reform, on purely monetary policies, or on the fiscal policies available to governments that believe that all deficits must be financed with debt will not reverse the world’s chronic deficiency of nominal demand.



Copyright: Project Syndicate, 2016.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Mar 18th 2024
EXTRACT: "....the UK’s current economic woes – falling exports, slowing growth, low productivity, high taxes, and strained public finances – underscore the urgency of confronting Brexit’s catastrophic consequences."
Mar 18th 2024
EXTRACTS: Most significant of all, Russia’s Black Sea fleet has suffered significant losses over the past two years. As a result of these Ukrainian successes, the Kremlin decided to relocate the Black Sea fleet from Sevastopol to Novorossiysk on the Russian mainland. Compare that with the situation prior to the annexation of Crimea in 2014 when Russia had a secure lease on the naval base of Sevastopol until 2042." --- "Ukrainian efforts have clearly demonstrated, however, that the Kremlin’s, and Putin’s personal, commitment may not be enough to secure Russia’s hold forever. Kyiv’s western partners would do well to remember that among the spreading gloom over the trajectory of the war."
Mar 8th 2024
EXTRACT: "As the saying goes, 'It’s the economy, stupid.' Trump’s proposed economic-policy agenda is now the greatest threat to economies and markets around the world."
Mar 8th 2024
EXTRACT: "Russia, of course, brought all these problems on itself. It most certainly is not winning the war, either militarily or on the economic front. Ukraine is recovering from the initial shock, and if robust foreign assistance continues, it will have an upper hand in the war of attrition."
Mar 8th 2024
EXTRACT: "...... with good timing and good luck, enabled Trump to defeat [in 2016] political icon Hillary Clinton in a race that appeared tailor-made for her. But contrary to what Trump might claim, his victory was extremely narrow. In fact, he lost the popular vote by 2.8 million votes – a larger margin than any other US president in history. Since then, Trump has proved toxic at the ballot box. " -----"The old wisdom that 'demographics is destiny' – coined by the French philosopher Auguste Comte – may well be more relevant to the outcome than it has been to any previous presidential election. "----- "Between the 2016 and 2024 elections, some 20 million older voters will have died, and about 32 million younger Americans will have reached voting age. Many young voters disdain both parties, and Republicans are actively recruiting (mostly white men) on college campuses. But the issues that are dearest to Gen Z’s heart – such as reproductive rights, democracy, and the environment – will keep most of them voting Democratic."
Mar 8th 2024
EXTRACTS: "How can America’s fundamentalist Christians be so enthusiastic about so thoroughly un-Christian a politician?" ---- "If you see and think outside the hermeneutic code of Christian fundamentalism, you might be forgiven for viewing Trump as a ruthless, wholly self-interested man intent on maximizing power, wealth, and carnal pleasure. What your spiritual blindness prevents you from seeing is how the Holy Spirit uses him – channeling the 'secret power of lawlessness,' as the Book of 2 Thessalonians describes it – to restrain the advent of ultimate evil, or to produce something immeasurably greater: the eschaton (end of history), when the messiah comes again."
Mar 1st 2024
EXTRACT: "The lesson is that laws and regulatory structures are critical to state activities that produce local-level benefits. If citizens are to push for reforms and interventions that increase efficiency, promote inclusion, and enable entrepreneurship, innovation, and long-term growth, they need to recognize this. The kind of effective civil society Nilekani envisions thus requires civic engagement, empowerment, and education, including an understanding of the rights and responsibilities implied by citizenship."
Feb 9th 2024
EXTRACT: "Despite the widespread belief that the global economy is headed for a soft landing, recent trends offer little cause for optimism."
Feb 9th 2024
EXTRACT: " Consider, for example, the ongoing revolution in robotics and automation, which will soon lead to the development of robots with human-like features that can learn and multitask the way we do. Or consider what AI will do for biotech, medicine, and ultimately human health and lifespans. No less intriguing are the developments in quantum computing, which will eventually merge with AI to produce advanced cryptography and cybersecurity applications."
Feb 9th 2024
EXTRACTS: "The implication is clear. If Hamas is toppled, and there is no legitimate Palestinian political authority capable of filling the vacuum it leaves behind, Israel will probably find itself in a new kind of hell." ----- "As long as the PLO fails to co-opt Hamas into the political process, it will be impossible to establish a legitimate Palestinian government in post-conflict Gaza, let alone achieve the dream of Palestinian statehood. This is bad news for both Israelis and Palestinians. But it serves Netanyahu and his coalition of extremists just fine."
Jan 28th 2024
EXTRACTS: "According to estimates by the United Nations, China’s working-age population peaked in 2015 and will decline by nearly 220 million by 2049. Basic economics tells us that maintaining steady GDP growth with fewer workers requires extracting more value-added from each one, meaning that productivity growth is vital. But with China now drawing more support from low-productivity state-owned enterprises, and with the higher-productivity private sector remaining under intense regulatory pressure, the prospects for an acceleration of productivity growth appear dim."
Jan 28th 2024
EXTRACT: "When Chamberlain negotiated the notorious Munich agreement with Hitler in September 1938, The Times did not oppose the transfer of the Sudetenland to Germany without Czech consent. Instead, Britain’s most prestigious establishment broadsheet declared that: “The volume of applause for Mr Chamberlain, which continues to grow throughout the globe, registers a popular judgement that neither politicians nor historians are likely to reverse.” "
Jan 4th 2024
EXTRACTS: "Another Trump presidency, however, represents the greatest threat to global stability, because the fate of liberal democracy would be entrusted to a leader who attacks its fundamental principles." ------"While European countries have relied too heavily on US security guarantees, America has been the greatest beneficiary of the post-war political and economic order. By persuading much of the world to embrace the principles of liberal democracy (at least rhetorically), the US expanded its global influence and established itself as the world’s “shining city on a hill.” Given China and Russia’s growing assertiveness, it is not an exaggeration to say that the rules-based international order might not survive a second Trump term."
Dec 28th 2023
EXTRACT: "For the most vulnerable countries, we must create conditions that enable them to finance their climate-change mitigation" ........ "The results are already there: in two years, following the initiative we took in Paris in the spring of 2021, we have released over $100 billion in special drawing rights (SDRs, the International Monetary Fund’s reserve asset) for vulnerable countries.By activating this “dormant asset,” we are extending 20-year loans at near-zero interest rates to finance climate action and pandemic preparedness in the poorest countries. We have begun to change debt rules to suspend payments for such countries, should a climate shock occur. And we have changed the mandate of multilateral development banks, such as the World Bank, so that they take more risks and mobilize more private money."
Dec 27th 2023
EXTRACT: "....if AI causes truly catastrophic increases in inequality – say, if the top 1% were to receive all pretax income – there might be limits to what tax reforms could accomplish. Consider a country where the top 1% earns 20% of pretax income – roughly the current world average. If, owing to AI, this group eventually received all pretax income, it would need to be taxed at a rate of 80%, with the revenue redistributed as tax credits to the 99%, just to achieve today’s pretax income distribution; funding the government and achieving today’s post-tax income distribution would require an even higher rate. Given that such high rates could discourage work, we would likely have to settle for partial inequality insurance, analogous to having a deductible on a conventional insurance policy to reduce moral hazard."
Dec 21st 2023
EXTRACT: "Shocks are here to stay, and our task is not to predict the next one – although someone always does – but to sharpen our focus on resilience. Staying the course of politically mandated policies while minimizing the inevitable dislocations is easier said than done. But that is no excuse to fall for the myth of being victimized by the unprecedented."
Dec 21st 2023
EXTRACTS: "A new world is indeed emerging. It will be characterized not only by more interdependencies, but also by more insecurity, danger, and war. Stability in international relations will become a foreign concept from a bygone age – one that we did not fully appreciate until it was gone."
Dec 14th 2023
EXTRACT: "Yet one must never forget that Putin is first and foremost an intelligence officer whose dominant trait is suspicion."
Dec 2nd 2023
EXTRACTS: "In a recent commentary for the Financial Times, Martin Wolf trots out the specter of a 'public-debt disaster,' that recurrent staple of bond-market chatter. The essence of his argument is that since debt-to-GDP ratios are high, and eminent authorities are alarmed, 'fiscal crises' in the form of debt defaults or inflation “loom. And that means something must be done.' ----- "If, as Wolf fears, 'real interest rates might be permanently higher than they used to be,' the culprit is monetary policy, and the real risk is not rich-country public-debt defaults or inflation. It is recession, bankruptcies, and unemployment, along with inflation." ---- "Wolf surely knows that the proper remedy is for rich-country central banks to bring interest rates back down. Yet he doesn’t want to say it. He seems to be caught up, possibly against his better judgment, in bond vigilantes’ evergreen campaign against the remnants of the welfare state."
Nov 27th 2023
EXTRACT: "The first Russia, comprising those living in Russia’s two biggest cities, Moscow and Saint Petersburg, can pretend there is no war at all." ---- "Then there is the other Russia, the one you find in small towns and villages scattered across the country’s massive territory. Here, the Ukraine war is a source of patriotic pride,"