Banking
ECB could solve eurozone crisis, leading economist says
http://www.dw.de/ecb-could-solve-eurozone-crisis-leading-economist-says/a-18374668
Adair Turner, former chief of the UK Financial Services Authority, is
the new chairman of the Institute for New Economic Thinking. He tells DW
calibrated use of the ECB's balance sheet could end the eurozone
crisis.
INET is a network of top-flight economists founded in the wake of the
2007-8 global financial crisis, generously funded by several
intellectually ambitious billionaire philanthropists. Its mission: To
reinvent economic theory and reconnect it with the real world. Adair
Turner took over INET's reins on the occasion of the network's sixth
annual conference in Paris.
DW: Lord Turner, you've been giving talks about how to deal with the consequences of huge debts left hanging over an economy after asset price bubbles burst - like the real estate bubbles in Spain and Ireland. How does your approach differ from that of German economic policymakers?
Adair Turner: The Bundesbank was ahead of many other central banks in that it was skeptical of pure inflation targeting. It had a policy of managing monetary aggregates, too. But the Bundesbank's idea was that if the money supply is growing too fast, that's a forward indicator of inflation. Actually it's not. It's a forward indicator of an asset price bubble. When the bubble eventually pops, the result is deflation, not inflation. The reason is that when people try to "deleverage," or pay down debts on a net basis, that causes the money supply to shrink - and aggregate demand to shrink with it.
Why does the money supply shrink when bank debts are repaid?
Banks create the circulating money supply when they grant credit to borrowers. Bank debt and bank credit - the latter is what we commonly call "money"– are two sides of the same coin, mirror images on banks' balance sheets. When bank debts are paid off, both the debt and the money used to pay it off disappear.
If more bank debt is repaid than is created in a given time period, the result is a reduction in the circulating money supply, and that means a reduction in purchasing power. The result is a recession, or even a depression. The economist Irving Fisher described the basic process in the 1930s in his theory of "debt deflation."
Germans don't like being in debt and don't like their governments endlessly piling up debt, either. Isn't there some other way of dealing with the aftermath of a bubble?
Yes, there is. But you need an additional tool to prevent deflation in the face of general deleveraging. You have to allow the central bank to give carefully calibrated amounts of debt-free money to governments to spend into circulation.
Lord Turner suggests using an available medicine, but in the right doses
But then eurozone rules prohibit central bank funding of governments.
Yes. The prohibition was put in place at the Bundesbank's insistence, because of a fear that if any monetary financing of deficits were allowed, governments would get carried away, print far too much money and create hyperinflation.
Now, a medicine can be a cure in small doses, yet be a dangerous poison in high doses. But does it therefore make sense to forbid that medicine from being used at all? No. What you need is sensible rules about dosages and procedures for carefully monitoring how the patient responds to them - and a qualified doctor who administers and adjusts dosages based on the observed results.
The ECB's balance sheet could be used to end the eurozone crisis. The way forward is to set clear rules in advance, defining under what conditions, how and to what extent financing of eurozone government deficits with sovereign ECB money would be allowed.
The rules should leave decisions about how much monetary stimulus the ECB provides entirely up to the ECB. The central bank would retain its policy independence. We'd merely be giving it a new tool to improve its ability to manage monetary aggregates and prevent depressions.
... and provide it with an instrument to get rid of too much money ...
You'd also give it tools for removing money from the system again when it deems it appropriate. For example, we could set up an adjustable financial transaction tax that flows money to the ECB. Whenever it thinks the economy is at risk of overheating, the ECB could stop passing the tax revenue along to governments for spending. It could put the money on ice or destroy it. Alternatively, the central bank could increase the reserve ratios it imposes on banks, to reduce their ability to make new loans.
There's a variety of possible calibration mechanisms - ways to either increase or draw back money from circulation as needed - depending on the state of the economy. As long as the rules are clear and well designed, there's no risk that monetary financing of government deficits would get used to excess.
Ironically, we currently have a rule against using the medicine that could cure the eurozone. At this point, it may be the only plausible remedy.
Lord Turner became head of the UK's FSA on September 20, 2008 - a week after Lehman Brothers went under - and steered the UK's main financial regulator through the ensuing five years of crisis and post-crisis management. Previously, he'd been a director, vice-chairman or chairman of a redoubtable list of private and public sector institutions and regulatory committees.
DW: Lord Turner, you've been giving talks about how to deal with the consequences of huge debts left hanging over an economy after asset price bubbles burst - like the real estate bubbles in Spain and Ireland. How does your approach differ from that of German economic policymakers?
Adair Turner: The Bundesbank was ahead of many other central banks in that it was skeptical of pure inflation targeting. It had a policy of managing monetary aggregates, too. But the Bundesbank's idea was that if the money supply is growing too fast, that's a forward indicator of inflation. Actually it's not. It's a forward indicator of an asset price bubble. When the bubble eventually pops, the result is deflation, not inflation. The reason is that when people try to "deleverage," or pay down debts on a net basis, that causes the money supply to shrink - and aggregate demand to shrink with it.
Why does the money supply shrink when bank debts are repaid?
Banks create the circulating money supply when they grant credit to borrowers. Bank debt and bank credit - the latter is what we commonly call "money"– are two sides of the same coin, mirror images on banks' balance sheets. When bank debts are paid off, both the debt and the money used to pay it off disappear.
If more bank debt is repaid than is created in a given time period, the result is a reduction in the circulating money supply, and that means a reduction in purchasing power. The result is a recession, or even a depression. The economist Irving Fisher described the basic process in the 1930s in his theory of "debt deflation."
Germans don't like being in debt and don't like their governments endlessly piling up debt, either. Isn't there some other way of dealing with the aftermath of a bubble?
Yes, there is. But you need an additional tool to prevent deflation in the face of general deleveraging. You have to allow the central bank to give carefully calibrated amounts of debt-free money to governments to spend into circulation.
Lord Turner suggests using an available medicine, but in the right dosesYes. The prohibition was put in place at the Bundesbank's insistence, because of a fear that if any monetary financing of deficits were allowed, governments would get carried away, print far too much money and create hyperinflation.
Now, a medicine can be a cure in small doses, yet be a dangerous poison in high doses. But does it therefore make sense to forbid that medicine from being used at all? No. What you need is sensible rules about dosages and procedures for carefully monitoring how the patient responds to them - and a qualified doctor who administers and adjusts dosages based on the observed results.
The ECB's balance sheet could be used to end the eurozone crisis. The way forward is to set clear rules in advance, defining under what conditions, how and to what extent financing of eurozone government deficits with sovereign ECB money would be allowed.
The rules should leave decisions about how much monetary stimulus the ECB provides entirely up to the ECB. The central bank would retain its policy independence. We'd merely be giving it a new tool to improve its ability to manage monetary aggregates and prevent depressions.
... and provide it with an instrument to get rid of too much money ...
You'd also give it tools for removing money from the system again when it deems it appropriate. For example, we could set up an adjustable financial transaction tax that flows money to the ECB. Whenever it thinks the economy is at risk of overheating, the ECB could stop passing the tax revenue along to governments for spending. It could put the money on ice or destroy it. Alternatively, the central bank could increase the reserve ratios it imposes on banks, to reduce their ability to make new loans.
There's a variety of possible calibration mechanisms - ways to either increase or draw back money from circulation as needed - depending on the state of the economy. As long as the rules are clear and well designed, there's no risk that monetary financing of government deficits would get used to excess.
Ironically, we currently have a rule against using the medicine that could cure the eurozone. At this point, it may be the only plausible remedy.
Lord Turner became head of the UK's FSA on September 20, 2008 - a week after Lehman Brothers went under - and steered the UK's main financial regulator through the ensuing five years of crisis and post-crisis management. Previously, he'd been a director, vice-chairman or chairman of a redoubtable list of private and public sector institutions and regulatory committees.
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