John Kay on helicopter money

John Kay has written the first in a series of posts on monetary policy, and he starts by trashing helicopter money.  I also disagree that HM should be contemplated, at least in any economy save Japan,  but I think he makes a misstep on his journey to the same conclusion.

The issue concerns whether fiat money is to be considered a liability of the public sector.  Many of HM’s proponents – Kay references Willem Buiter – start from the presumption that it is not.  And from there deduce that handing out paper that is an asset for the recipients, but not a liability for the issuer, will stimulate spending.

Where Kay goes wrong – I think – is in asserting that money is a liability of the public sector from having noticed that the government will currently accept it as payment by the private sector in respect of liabilities to it – eg taxes owed.

Kay’s observation that governments do this now is of course correct.  [Perhaps with the exception of a few Communist countries where state shops only accept foreign exchange].  But that is not enough evidence to decide on the question posed by the HM modellers and their adversaries.  That conversation is about whether the following statement is true:  ‘should we model the effects of HM [or any policy] by taking it that the public sector promises, come what may, to levy a stream of future taxes [net of spending] to reimburse the private sector for the real value of the entire stock of bonds and money?’

That up until now governments have taken cash in payment of taxes cannot decide this question.  It may simply tell us that the government goes along with the coordinated view that money is to be accepted because it knows that it can get rid of it again, and is behaving, therefore just like any other private individual.  It may indicate what John Kay wants it to, which is that the government is seeking to nurture the value of money by indicating that it values it, and perhaps that could be stretched to suggesting that the government stands ready to make good on all the money issued.  But we can’t be certain.  And it’s resolve to do that might be sorely tested by a sudden rush of demand to pay down tax obligations in cash.   Or, at least, expectations about its resolve might be so tested;  and especially by observing that the state was resorting to HM.

The question argued about by the HM debate participants is a behavioural one, and it concerns the behaviour of the government in the future.  So I’m not sure what evidence you could use to decide conclusively on the point at issue here.

I don’t side with Buiter, however, as I explained here some time ago.  He knocks out one assumption in the standard model – that money is not treated as a liability by the public sector – and uses the rest of the model to conclude that HM is always effective.  But in doing so he leaves in place the assumption made in that model that people value money for its own sake.  This is a piece of analytical sticking plaster.  Put there to proxy for otherwise unanswered questions about why people value money.  IMO if you take away the assumption about the public sector treating money as a liability, leaving this other assumption in – that people value money for its own sake – has less validity.

To decide properly on this, we need to go to deeper models of money, not partially dismantle a superficial one.  And that means studying HM in the kind of models built by Steve Williamson and his tribe [Wright, Lagos, Kiyotaki etc], or at east the older overlapping generations models of money.  I haven’t thought or read about HM in these models so don’t know what they would have to say on the question.

[I should acknowledge that this post came out of an exchange with AN Other anonymous monetary economist, without implicating them in any mistakes here.]

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One person’s enlightened stabiliser is another’s wrong-headed sop

In my previous post I identified the vortex caused by responding to perceived grievance  with a policy sop  that is wrong headed and subsequently gives ground for further grievance and another round of misdiagnosis by the electorate.

Of course it remains a further difficulty for the chance of good outcomes to prevail that those who think they know – or are at least paid to – often disagree about whether a policy is wrongheaded or enlightened.

For example, the mainstream economics and finance establishment view the steps taken in financial regulation since the financial crisis of 2008 as an enlightened response to the risks in the system that previously were not fully apprehended. However, those with less faith in public intervention – John Cochrane being a notable example – often write about the new legislation and public trespassing in private financial markets as if this is a wrongheaded policy sop  responding to  a perceived grievance in a way that  will inevitably lead to further crises.

Relatedly  I had the honour of  a  bashing from Wolfgang Munchau  who accuses me of arrogance for pronouncing Brexit  to be a bad idea  that would not help those who voted for it.

Obviously,  and having campaigned as part of the economics Remain  effort,  I don’t agree that there is any doubt that the many  likely Brexit outcomes  will harm.  But  the piece does make, along the way, the general point that there is still debate to be had about what rational policy is and that no one expert could claim unchallengeable authority on the question.

It is somewhat ironic, however, that this point is made in the context of an article that explains something of the awful  protracted nature of the exit process and agreeing new terms of trade!

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The perceived-grievance-wrong-headed sop vortex

That title, strangely, does mean something.

Post-Brexit, post-Trump, post-financial crisis, there’s a desire to respond to the perceived grievances of those who voted to give incumbent governments a kick.  But in so far as these grievances are not genuine, responding to them in ways that harm everyone and don’t address the economy’s underlying problems sets us all up for a vortex of ever diminishing prosperity and more spiteful policies and politics.

So, for example, we had ‘quantitiative easing for the people’, framed to respond to quantitative easing that was just for bankers, and harmed old savers.  This policy would dismantle monetary and fiscal credibility, likely harming those whose portfolios are unsophisticated.

Now the UK is embarked on Brexit, voted for by the older, less educated, less skilled.  This will shrink the size of the economy in the long run and seems likely to pitch us into a protracted period of weak growth or recession to which we are ill-placed to respond.  Both malaises, certainly the latter, will be disporportionately felt by those at the bottom of the pile whose Brexit vote got us here.  The journey of concluding new trade arrangements will set off a new round of industrial reallocation, and choke off immigration.  This will not benefit those who voted for Brexit, except in their imaginations.  In fact the process of reallocation may well, if past such experiences are to be repeated, hit hardest those who are oldest, and have least time or aptitude to retrain, or are least able to relocate.

Taking perceived grievances at face value entails several risks.

The policy response shrinks the aggregate size of the pie, hurting all, and does not help the aggrieved constituency.  In the next round, the wounded group takes aim at a new component of the status quo, dismantling our wealth creating machine even further.

Another risk is that responding legitimises unfounded prejudice: a slope much slippier than those involving a purely economic calculus.  It is hard to write about this without descending myself into a level of vitriol which leaves me little different from the populists.  But the point has been addressed by many others.

Yet another risk of the unfounded sop response to the perceived grievance is that it rewards dishonest political opportunism.  That industry is a machine that searches for prejudicial diagnoses, manufactures them into political power and chaos, but producing, this blog contends, just more grievance to begin the process afresh, each time more vigorously than the last.

Is there a way out of this?  I’ve no idea, but it’s incumbent on the believers to keep banging on the many drums of rational policy discourse.  That our state capacity should focus on the real problems;  improving its insurance functions for those subject to more of the adjustment costs posed by closed and open economies alike;  redistributing to the young;  relatedly, addressing the housing and planning problem [specific to the UK];  doubling down on the functions where there is a comparative advantage and need, like health and education, and not invading spheres where there is little [like industrial scale pharmaceutical research!];  that migration, whatever focus groups and opinion polls say, is almost entirely beneficial.

If only all that could be sloganised effectively enough to get enough people angry enough to vote.

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Resetting the fiscal framework in the UK

Following on from my previous post….

Phillip Hammond has suggested a ‘reset’ of fiscal policy might be in order, which could be read as him recognising that monetary policy might not be able to offer an adequate response to the potentially recessionary shock that the Brexit vote imparted.

But in the absence of a proper fiscal framework, it’s he who gets to decide how much stimulus, if any, is imparted.  And there is nothing binding him to explain what the objectives are.  Moreover, while everyone else stays in the dark about what is meant by a reset, there can be no confidence over what future monetary policy will be, since that will depend in large part on the fiscal response.

Ideally, Hammond would be obliged to make up for monetary inadequacy if it was agreed that monetary policy was inadequate.  Though he could undertake more than was necessary, he could not, without suspending the fiscal framework, do less.  Something on which the BoE, and all those who depend on her to figure out their long term financing costs, could depend.

And if Hammond were to do more, perhaps by engaging in deficit financing of public investment, there would be an open and independent assessment of how the costs of this would be met by the forecast returns from that future investment.

Whatever happens, the reset has to be done with care.  It would be nice to think that the reset gets us closer to an ideal fiscal framework, one that is robust to the zero bound to monetary policy, which we are likely to live near for quite some time to come.  And it would be nice to think that after a good reset, there would fewer such resets in the future.

Monetary policy has not had any resets, really, since the enlightened one of 1997.  The Bank of England Act can be modified by a straight majority of Parliament.  The inflation target, and instructions to weigh deviations from it against fluctuations in real activity, can be modified simply by the Chancellor writing a letter.  The real obstacles to messing with monetary policy were the existence of a cross-party consensus that the Bank of England was mandated to do the right thing, and the slowly growing reputational cost that messing after a period of no messing imposes.

Given the scale of disagreements between political factions about what fiscal policy should do, these hopes might seem utopian.  But before the inflation target was first thought of in 1992 in the UK, there were similarly disagreeing and vague conceptions of the role of monetary policy.

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Monetary-fiscal coordination

People may differ on the effectiveness and desirability of unconventional monetary policy. But most of those in the sensible camp would agree that if we were about to head into recession, the most important aspect of the policy response is not what the Bank of England will do but how the Treasury will respond. To that end now is one of those times when it would have been much better to have had monetary and fiscal policy coordination hard-wired into the framework. My preferred system for doing this would be one in which the Bank of England’s monetary policy committee decides, after considering the limits to both conventional and unconventional monetary policies, how much stimulus it thinks it is missing. It then communicates this in some commonly understood units (perhaps equivalent changes in VAT) and then it is over to the Treasury to consider both whether it agrees with the missing stimulus analysis and, if so, how it intends to respond. The office for budget responsibility then has a role in checking whether the Treasury’s response is consistent with the long-term fiscal framework. The closest approximation to this  that we have seen was the counter to the Osborne fiscal Charter, owned by John McDonnell, and presumably written by Simon Wren Lewis. The situation we find ourselves in now is one in which the Chancellor talks of ‘resetting’ fiscal policy, which no one really understands, and where central bank governor claims to have all the tools necessary to hit the inflation target, which we know cannot always be true but which is an understandable attempt at instilling confidence.

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QE for the sceptical Monetary Policy Committee people

On the assumption that the Monetary Policy Committee loosen at their August meeting, the question arises as to what unconventional policy might be undertaken. There is a clear indication in the July minutes that this is under consideration. I have been asked many times in the last two weeks what they will do and find myself at a loss to guess. There are two difficulties in trying to figure it out.

First, by revealed preference, Carney and others have been sceptical about the worth of purchasing government securities. A few reasons for saying this: to begin with I’m sure that Carney himself went on record while he was at the bank of Canada on the subject, though my RSI prevents me from doing a thorough check now. If anyone knows for sure, please let me know. Another reason: during the time between Carney was appointed as governor in 2013 and when he actually took up post, the bank was reviewing the usefulness of forward guidance as a means to impart further stimulus  which there was a fair case for that time. Carney was clearly very much in favour. And that was no talk then of simply extending asset purchases and not bothering with what might have been viewed as a risky communications innovation. Of course by the time late summer 2013 came, the economy had moved on somewhat and the case for further stimulus evaporated. So although forward guidance was undertaken Carney was left with the awkward task as presenting it not as a means of further stimulus but as a means of providing clarity about future interest rates. A final piece of evidence: one can view the last two years as a sequence of disappointments as inflation continued to stay stubbornly below target refusing to return back to it as previously projected. The committee under Carney was content to respond to these disappointments by signalling either explicitly or implicitly – and not always terribly well – that the time at which interest rates would begin to rise had been postponed. An alternative, course, would have been to undertake more asset purchases. The fact that this alternative was set aside indicates that such purchases were maybe viewed as undesirable or ineffective.

The Committee may think instead about purchasing private sector assets. But getting into a position where the bank can execute these on any significant scale requires many operational steps, several of which will be hard or impossible to undertake in secret. For example, to do this in an orderly way, and in a way which minimised financial risk to the bank, or reputational risk, would require announcing in advance what kinds of assets will be purchased, consulting on the design of platforms on which this will be done, and the design of reverse auctions, and perhaps even hiring significant credit risk capacity (which the Bank of England does not currently have) all contracting this out somehow.

So my best guess would be that if the bank is thinking seriously about this it is only as a contingency, and they would not currently be anywhere near ready to do it. The post Brexit evolution of the macroeconomy does not look good. [Viz this morning’s PMI release].  That said, some of the really scary scenarios involving a meltdown in financial markets, do not yet look like materialising. But that said, given how seriously the bank clearly took such possibilities before the vote, it’s curious  – if indeed I am right about inferring this lack of readiness from a lack of outward signs– that more was not done in advance by way of practical preparation for the purchase of private sector assets on behalf of the monetary policy committee.

So, if you are one of those who has not yet asked me what the Monetary Policy Committee will do in August, you can see from the above as it is probably not worth asking me.

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The Bank of England expects it will want to loosen, but didn’t

Yesterday the Bank of England’s monetary policy committee decided not to cut interest rates, despite most forecasting that it would. There was an innovation in monetary policy communication however. Although it would not cut rates today, the minutes revealed that most MPC members expected to vote for more stimulus at their August meeting.   This was  a very clear departure from the old practice, under the previous governor, of, as Mervyn King used to put it ” playing one ball at a time”.   This part of the decision is welcome. Many both inside and outside the Bank of England have been explaining the benefits of this kind of forward communication. Monetary policy works not just via current rates but via expectations of future rates. If a committee has a sense of what it intends to do in the future, it should communicate that as clearly as it can to those who are affected by its decisions.   Policymakers that I spoke to usually objected to this logic  on the grounds that it was too difficult for committee to vote formally on an interest rate path,  and that was a danger of a forecast being taken as a promise, and therefore of the committee suffering reputational damage when it did not keep the apparent promise.  To some extent these difficulties seem to have been swept aside by this little detail of the July 2016 minutes.

However, the July decision by the majority (one dissented) begs the question: if the committee thought it would  loosen at its next meeting, why not loosen now?   The reasoning seems to have been the following: although the committee recognised that monetary policy was too tight, it did not know exactly how much loosening was needed, and it would not know with enough precision until the staff had gone through the process of compiling the August inflation report forecast. There was therefore a possibility that the committee might loosen now, and then have to loosen by more in August, or even undo some of the loosening. The majority must have judged that the risk of looking incompetent by tinkering with the instruments each month in this way outweighed the benefits  of moving promptly.

The dissenter, Jan Vlieghe, took what I interpret to be a more nuanced view.   The logic may have been something like this. It was clear that interest rates would have to be cut down to a new lower floor, and more easing would need to be imparted by asset purchases. It was highly unlikely that a 25 basis point cut to rates would need to be reversed. Even if this were so, it is pretty costless to reverse interest rate changes. Zigzagging asset purchases could be much more costly and make a mess of debt management. So cut rates now, and wait until there is more certainty about how much extra stimulus needs to be imparted through asset purchases.

Why the others could not go along with this is not clear. Perhaps the others don’t agree that  the new floor is 25 basis points.  If the new floor was judged to be zero, then cutting that far in advance of an inflation forecast would raise the chance of having to reverse course later.Or perhaps they think that the shock and awe effect would be diminished by imparting stimulus with one tool in one month, and another tool in another month.

Today, text of a 30th of June speech by Andrew Haldane was released, in which he calls for a “prompt” and “muscular” loosening. For my money, the loosening won’t be as prompt as it could have been. Although I can see the logic of waiting, I’m sceptical that much will be got by way of precision about exactly how much loosening will be needed from doing another inflation forecast. And it remains to be seen whether, however much unconventional monetary policy is undertaken, this is effective enough to amount to something that could be described as ‘muscular’.

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