From the FT:
Sir,
Dennis Leech (Letters, February 22) attacks a piece of conventional wisdom, namely that bigger deficits lead to more debt. However, his argument is simply that the rise in debt will be smaller than the rise in gross domestic product, hence the debt to GDP ratio falls.
There is actually a far more fundamental weakness in the idea that deficits necessarily lead to more debt. This is that, as pointed out by J.M. Keynes in a letter to F.D. Roosevelt in 1933, the country can expand the deficit any amount it likes without any extra debt whatever, and simply by printing money.(1) Milton Friedman made the same point. And as for the idea that money-printing leads to inflation, those two great minds, fantastic as it might seem, thought of that [as] one.(2)
In practice, the latter is what we have done with quantitative easing.(3) The only nonsensical element remaining from QE is to continue counting debt in the hands of the central bank as debt. Those gilts might as well be torn up.(4)
Ralph Musgrave, Durham, UK
1) Printing money, i.e. bank notes, has ultimately the same effect as borrowing money. Bank notes are just non-interest bearing, low denomination government bearer securities. It would make little difference, in the grander scheme, whether the government gave somebody a suitcase with £1 million in bank notes in it, or whether the government issued him with a gilt with a face value of £1 million at a market interest rate.
2) I think there was a typo in the version as published.
3) QE is not actually printing money, it is just converting long term debt ("gilts") to short term debt ("deposits by commercial banks at the Bank of England"). The inflationary impact thereof is largely because this pushes down average interest rates (in the short term at least); the UK government was paying (say) 2.5% interest on the bonds it bought back and is only paying 0.5% on the deposits. So the people who have sold their higher yielding gilts and now hold low-yielding "cash" are looking round for something else to invest in (which leads to asset and commodity price bubbles).
4) "If you don't agree with any of it, why is this your reader's letter of the day?" you might ask. Well, firstly because Ralph is a blogging friend, and secondly because of the last two sentences - it's so nice to see them in print.
Remember: the deposits which the Bank of England has taken from the commercial banks are real debts*, and those have replaced the old debts (the gilts) - it's like you paying off your credit card debt by taking out a second mortgage on your house - so the old debts, the gilts themselves, the bits of paper, now merely serve as a record that one department of HM Treasury (the Debt Management Office) owes a different department (the Bank of England) money. But you cannot owe yourself money, can you?
* Merrily glossing over the fact that the Bank of England now owes a lot of these to nationalised banks, i.e. RBS or Lloyds could withdraw the deposits and use them to repay the soft loans which HM Treasury/the Bank of England gave them as part of the bank bail out of a couple of years ago etc.
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18 comments:
For years I thought that Milton Keynes had been named after these two economists but then I came across an old map that showed that Milton Keynes was the name of a village that stood where the New Town was built.
B, yes, that's one of my favourite misunderstandings.
"Bank notes are just non-interest bearing, low denomination government bearer securities."
How does it work in Scotland, where the banks issue their own notes, even the non-nationalised ones?
B, bank notes are IOUs, the only important thing about IOUs is the credit worthiness of the issuer (and the interest rate).
Long term gilt yields rose during the 2009 QE program; the 10y gilt was at approx 3% at the beginning of Mar '09, around 4% after they had "printed" £200bn by Jan '10. The effect of successful monetary easing on interest rates is always misunderstood. When central banks successfully ease monetary policy, what happens? Bond yields drop, stocks go up.
That people "look round for something to invest in" is exactly what the government wants them to do. This is the "hot potato" effect of the extra monetary base, which suggests QE can have a behavioural effect on real spending.
You have suggested now that QE "had no impact on the economy" and that QE creates asset/commodity bubbles. Which is it? Are you completely indifferent to whether your stock portfolio is worth £0 or £50m? As a corporate sitting on £100m, when choosing between buying capital goods or acquiring a competitor, are you indifferent to their stock price? Prices have real effects.
Also, it is hard to see that issuing a tonne of short-maturity Treasury bills and buying back long-maturity bonds would have the same effect, because that would not involve an increase in the monetary base. It would be better if the Bank did not pay interest on excess reserves, so they are more "like money", for sure.
Imp:
Para 1, possibly true, but rates are still lower than they otherwise would have been. Not clear whether you think that QE was "successful" or not.
Para 3, I mean no impact on the REAL economy, employment, output etc. Asset price bubbles are not real, QE does not increase employment or real output.
You also wildly overstate the asset bubble effect. If you're thinking of buying a competitor and his stock price has gone up and so has yours, it doesn't make very much difference in terms of takeovers/mergers.
Para 4: " that would not involve an increase in the monetary base."
Feel free to believe the propaganda, or try and trace the actual logic and accounting of QE.
Fact is, government gilts were reduced by £325 billion and deposits with Bank of England were increased by £325 billion. Long term government borrowing was swapped for short term government borrowing. This has bugger all impact on "the monetary base", it might be a subtle shift between M3 and M4 or something, but those are meaningless figures.
Rising long-term rates is a sign of successful monetary easing, yeah.
The Bank said that QE should boost nominal spending. Between 2008 Q2 and to 2009 Q1 UK nominal gdp fell sharply, and only started rising after they started QE. There is certainly a correlation, and from the nominal there is a subsequent link to output/employment.
It's surprising people find still this stuff controversial: "print more money" was Friedman's prescription for the Great Depression. Scott Sumner and others have been persuasive modern advocates; they place far more weight on central banks moving expectations, and are less enthusiastic about ad-hoc QE.
I've no issue with your QE accounting per se, the pertinent point is about the nature of the liabilities. I can't spend Treasury bills in Tesco. I can spend the monetary base in Tesco if I have some (as physical cash), or if my bank does (reserves). Money is different to other assets.
Imp, let's stick to proven facts.
"I've no issue with your QE accounting per se, the pertinent point is about the nature of the liabilities. I can't spend Treasury bills in Tesco. I can spend the monetary base in Tesco if I have some (as physical cash), or if my bank does (reserves). Money is different to other assets."
You can't spend bonds or T-bills in the shops, but neither can you spend electronic balances which your bank holds with the BoE in the shops. You can only withdraw money from your personal bank account in the shops, and the amount of money in your personal bank account is unaffected by QE.
I fail to see how it affects your spending power when the bank with whom you deposit your own money changes the nature of its asets/investments.
Economics is a study of human behaviour, not of "proven facts". Otherwise we'd just call it "accounting".
"but neither can you spend electronic balances which your bank holds with the BoE in the shops"
But that is exactly what happens when I spend money at Tesco: I cause reserves to move between my bank and Tesco's bank account at the BoE.
What do you think is the transmission mechanism between QE and asset prices, if not the "hot potato" effect? You seem to accept there is a behavioural response - but that it must be limited to the prices of certain types of financial asset which necessarily have no effect on output. What's the logic?
If QE boosts equities, corporate bonds... why not also commercial property? If QE boosts commercial property prices, cet.par does that spur more or less real investment in new property?
Here's another one: if defined benefit pension schemes are in deficit because of low asset values corporate earnings must be redirected to reduce the deficit. High asset values therefore free up earnings for other uses (remuneration, dividends, investment ...).
Imp, try to walk before you can run, eh?
"that is exactly what happens when I spend money at Tesco: I cause reserves to move between my bank and Tesco's bank account at the BoE"
You cannot spend more cash in Tesco than you have in your account. Quite how Tesco and your bank settle up at the end of the day is largely irrelevant.
"if defined benefit pension schemes are in deficit because of low asset values corporate earnings must be redirected to reduce the deficit. High asset values therefore free up earnings for other uses (remuneration, dividends, investment ...)"
More codswallop, I'm afraid. yes, QE must have pushed up share prices, but it also pushed down interest rates; low interest rates = lower discount rates for calculating future liabilities = higher current liabilities = bigger pension fund deficits = less investment.
The pension funds were moaning recently that low interest/discount rates had pushed them into deficits; this effect more than cancelled out increases in share prices.
Come on, answer the question. How specifically does QE affect asset prices such that it cannot affect real spending, only financial assets? What's the transmission mechanism?
I agree that UK QE (2011-12 edition) has not be successful thus far. QE (2009-10 edition) pushed UP (long term) interest rates AND asset values. This improved both the liability and asset side of pension funds.
Imp: "How specifically does QE affect asset prices such that it cannot affect real spending, only financial assets? What's the transmission mechanism?"
The aim of QE was to push down interest rates (in which it succeeded, rates are lower than they would have been). Lower interest rates push up asset prices because of leverage, the amount of "real money" involved is the same, it's just more highly leveraged with made-up money. Like the recent house price bubble, do you remember that one?
There is little or no transmission mechanism between higher asset prices and real spending in real economy, or to the extent there is, it cancels itself out.
Now you answer my question - how does QE increase the amount of money in your bank account?
"rates are lower than they would have been"
Wait, is that a "proven fact"? That claim is no stronger than the BoE's claim that nominal spending is higher with QE than it would otherwise have been.
"how does QE increase the amount of money in your bank account"
I would suspect that the macro effects dominate, but I'd also guess at micro/ personal level the effect on mortgage rate spreads is significant on my own level of spending today, spreads had blow out in late 2008 but compressed hugely in 2009. If you look at many risk assets (e.g. junk bonds) the valuations fell to their lowest point in March '09. I'm sure QE starting in March '09 was a total co-incidence though.
House prices are at about 2006 levels. Was 2006 not a bubble year? What is the "correct" price for houses? Should I prepare to default on my mortgage?
Imp: "I would suspect that the macro effects dominate"
That's not a very meaningful answer, is it? You could always do the decent thing and admit that QE does not make any household one penny richer (unless they happen to be bankers).
"the effect on mortgage rate spreads is significant on my own level of spending today"
As it happens, bank lending spreads widened significantly (i.e. mortgage rates minus deposit rates) in the past few years and in tandem with the low rates induced by QE, so overall, households had LESS money to spend because the savers lost more income than the borrowers gained.
Not meaningful? I suspect that without QE in 2009 UK unemployment would have been much higher. Would I still have a job? Who knows.
Not richer? I thought you agreed that QE boosted financial asset prices? The index funds in my ISA have certainly gone up a lot since March '09. Doesn't that make me... uh... richer?
Is that another "proven fact", that household income would be higher without QE? Because you say so?
Imp, look, if all your shares go up in value, do you have more money to spend?
Nope.
You can sell them, of course, which gives you more money to spend, but the person who buys them has less money to spend.
The amount of real money to spend, and the real capacity of the economy to create goods and services is entirely unaffected. During the house price bubble the savings rate was negative and our balance of trade worsened markedly.
Can you please actually stop for a second and think through the logic before posting?
I find this comment of yours particularly irritating: "I thought you agreed that QE boosted financial asset prices?"
You are saying that as if you had wrung some sort of concession from me because of your superior knowledge and debating skills. Nope, I said that from the off, I have never denied it.
But you appear to subscribe to the Home-Owner-Ist thinking that if asset prices go up, people are richer, which is insanely untrue, so you might as well stop debating right now.
I'm sorry to be irritating. Your comment about "proven facts" followed by a bunch of counterfactual analysis rather wound me up.
You can't have it both ways on the current account and saving. UK saving/dis-saving is not a zero sum game exactly because of the current account.
I entirely agree that the QE does not increase the supply capacity of the economy. Monetary policy affects demand. But weak demand goes hand in hand with expectations of FUTURE weak demand, which means people are doing less real investment now.
Weak demand is harming the long-term supply capacity of our economy by suppressing capital formation. And it also encourages the idiots in government come up with crackpot fiscal "stimulus" schemes. It's monetary policy or Ed Balls will end up in charge. Who wants that?
What does the "amount of real money to spend" mean? The monetary base is the only "real money" in a sense. The liabilities created by the banking system is the "fake money".
Imp, I'm absolutely baffled as to what your point is.
The point of the post was item 4) Ralph Musgrave pointed out in his letter that gilts in the BoE could be torn up and nobody would notice. Which is of course correct.
You have since hared off in a number of different directions, you seem deadly keen to somehow prove me wrong on [whatever] but apart from that, what?
I don't do "counter-factual analysis" (which I take it is polite for 'lying'?) I look up stuff, I think about stuff, I check and re-check stuff painstakingly and at length, and then I do blog posts on it.
If you want to go along with the myth that "QE pumps money into the economy" then feel free, but it is simply not true, neither in cold accounting terms nor in "macro" terms (whatever they are) nor in actual measured GDP or employment levels. QE is smoke and mirrors bollocks to bail out banks by depressing interest rates, end of discussion.
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