The dangers inherent in the speech Lord Turner gave last night

Last night Adair Turner gave a speech at the Mansion House in the City of London and set out his stall to become the next Governor of the Bank of England. There are a couple of ways in which in true Yes Minister style he is ideally equipped for the job. Firstly he was a  advocate for the UK to join the Euro so on one of the most important policy issues he was completely wrong. It sends a chill down my spine thinking of the mess we would be in if our housing market had boomed  like Spain’s or Ireland’s did in response to interest-rates set for Germany’s benefit, let’s face it we have problems enough without that too. Also as chairman of the FSA he was not responsible for pre-2008 problems but nothing was done about the LIBOR scandal with the suspicion that it was hushed up.

Indeed last night to use modern vernacular Lord Turner felt the need to “fess up” about another recent policy error he has been involved in via his role on the Bank of England’s Financial Policy Committee.

For the last year, the FPC has been struggling with a trade-off – and I suspect our communication might have been clearer if we had been more explicit about how difficult that trade off is.

What he means is that the Bank of England has been pursuing policies which are mutually exclusive. Trying to get banks to lend whilst telling them to hold more capital also known as restricting their ability to lend! It is amazing how often the so called “Great and the good” are in fact neither.

So in Yes Minister terms the claimed novelty of having a Governor who is both honest and intelligent seems unlikely to occur should Lord Turner get the job.

What did he say?

There was a crucial component in the speech which to give them credit BBC News 24 broadcast live and it was this and the emphasis is mine.

So optimal policy also needs to include a willingness to employ still more innovative and unconventional policies, and to consider the combined impact of multiple policy levers – monetary policy, Bank of England liquidity insurance, prudential regulation and direct support to real economy lending – which we used either to consider quite separately, or else avoid entirely.

Okay so what does he mean?

Quantitative Easing is admitted to be a failure

I believe that this section of his speech is revealing enough as it confesses to issues with the effects of QE but once decoded I think it is as near as we have got to an admission that it has failed in the UK.

But quantitative easing alone may be subject to declining marginal impact, the economy facing a liquidity trap in which replacing private sector holdings of bonds with private sector holdings of money has little impact on behaviour and thus on demand

In a section that was probably hoped to be missed there was an admittal that QE has been inflationary. It was tucked behind the word growth-of which by contrast we have had precious little- but it was there. Phrases such as “slightly higher ” and “as best we can tell” are different to what Lord Turner would have told us when it started.

What alternatives are there?

Negative Interest Rates

I discussed this subject yesterday and to my mind this would be a likely option for “unorthodox” policies. It is already happening in some countries and frankly given its set-up I have been surprised that the current Monetary Policy Committee has not moved nearer to it.

However I am not a fan because I believe that we are already in a zone similar to the concept of a liquidity trap where cuts in interest-rates have less and less effect. As we moved below 1.5% to 2% I not only believe that they had little effect but the effect may have moved backwards. I will expound on this in subsequent articles but I believe that the effects on savers, inflation, confidence and expectations have counter-balanced any of the gains that economic textbooks predict. Going negative would be likely to have more negative effects in my opinion.

Cancelling government debt or helicopter money

Robert Peston of the BBC has suggested that this is an option Lord Turner favours and it made me wonder if Lord Turner had whispered it to Robert’s father on the House of Lords benches. Here is his view.

it is understood he believes the Bank of England should consider telling the Treasury it never has to repay some of the £375bn of government debts the Bank acquired through quantitative easing

Actually he is confused on this point as if you think about it the Treasury would have to give the Bank of England permission to tell it that the debt is cancelled. Oh what a tangled web and all that!

What would this mean?

As we stand right now we have seen the Bank of England buy government bonds in return for money. So the seller emerges with cash/money/liquidity and right now there is just under £366 billion of such funds in existence (it will reach the £375 billion in three weeks time at current purchasing rates). It was supposed to give an economic stimulus but as time goes by ever more of its previous supporters drop by the wayside (and hope that we do not notice that).

So if the bonds are cancelled there is no mechanism for the cash to be returned and our monetary system would remain with an extra £366 billion in it.

Does this matter Shaun?

Right Now

Because of the nature of our economic crisis the immediate impact would be minor compared to the longer-term effects when we (hopefully) have an economic recovery. I have argued plenty of times on this blog that the UK ‘s monetary transmission mechanism is broken and that we have many of the symptoms of a liquidity trap.

However even Lord Turner admits that QE has created some inflation and this does have impacts. In such a time where many are facing severe constraints on their income even inflation on a path 1% or 2% higher than otherwise will be like a noose around their necks especially if we recall that we have already had three years of this meaning that real wages have and are still falling. Regular readers will know that I worry about our poorest citizens and would like to point out one more time that such a policy will hurt them the most.

What about going forwards?

The situation of inflation somewhat higher than otherwise would persist until we reach the hoped for nirvana of a genuine economic recovery. At this point the extra money in the system will return to full or if you like normal power and if UK economic history is any guide will give us a more sustained burst of inflation. How high and how sustained will depend on how quickly the Bank of England responds to it.

A Problem

When this occurs I feel that at best the Monetary Policy Committee is likely to dither. They will be terrified of cutting off the recovery by their actions and so they will wait and wait before they act to remove this extra liquidity. In short they will have a prima facie failure as they will be acting like the politicians they were supposed to be an improvement on. So the monetary stimulus will remain at exactly the wrong point in our economic cycle and will cause our economy to overheat one more time.

So for such a policy to work you have to have faith in the integrity and ability of the Bank of England just as its reputation on both fronts is at an all-time low. This moves me onto a subject I intend to explore further in future articles which is that such failures introduce a negative influence on the economy via confidence and expectations. Sometimes intangible influences are more powerful than tangible ones.

Where is this leading?

I suspect that cancelling public-sector debt would also be combined with an increase in government spending or would give the opportunity to do so. With our national debt cut “at a stroke” so to speak it would be argued that we have more scope for expansionary fiscal policy. I do not want to get too much into the debate as to whether this is a good idea today apart from pointing out a consequence of this too.

To work this would require a belief that the extra public spending would be reversed in the future. As over our economic history we have proved capable of reducing the growth rate of public spending at best this is not entirely reassuring! So higher taxation would be required assuming of course they choose to cut back. Hopefully some of this would be offset by some economic growth but that is by no means as certain as its advocates would have you believe.

So we would be in danger of overheating quickly in any recovery and in an attempt to get ourselves out of one mess we would have lept into another and that is on a relatively optimistic scenario. As Oliver Hardy regularly said.

That’s one fine mess you got me into

My Future

Mindful Money has hit difficulties and I am not sure how long it will continue. As I have plenty to say and have plenty of plans for the future I wish to make it clear that I intend to continue blogging and should Mindful Money close my thoughts and analysis will return to.

http://notayesmanseconomics.wordpress.com/

This entry was posted in Debt, General Economics, Gilts, Inflation, Interest rates, Quantitative Easing and Extraordinary Monetary Measures, Stagflation, UK Inflation Prospects and Issues. Bookmark the permalink.
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  • Drf

    Hi Shaun;

    “To work this would require a belief that the extra public spending would
    be reversed in the future. As over our economic history we have proved
    capable of reducing the growth of public spending at best this is not
    entirely reassuring!” I think you perhaps may mean here “…we have proved incapable of reducing…”? Then again it is not that “we” have proved incapable, but it is the politicians who are incapable!

  • Anonymous

    Hi Drf
    Apologies for that sentence which is not entirely clear. I have added the word rate to it which I hope clears it up.

  • Andy Zarse

    Hi Shaun, having read your last three blogs on the ESM, negative interest rates, and now the amazing postulations of Red Adair, I sat staring at the computer screen this morning wondering if I hadn’t accidentally logged into the meeting minutes for The Magic Circle! There really is some crazy stuff going on out there, so can I take this opportunity, maybe for the last time on MM, to say thank you for trying to make sense of it to those of us who are mere mortals. Incidentally, is it possible to comment on the notayesman blog?

  • Andy Zarse

    Politicians are about as capable of doing this as the FSA are of regulating financial products…
    Oh, wait!!
    Here’s a couple of questions Lord Turner never answers.
    Where was the FSA when the banks were selling PPI for a ten year period? And why don’t any lenders now sell it; surely the protection it affords (paying off debt when illhealth or redundancy strikes) would be good for at least some consumers if it was properly priced? Why have the FSA totally over-regulated its sale – meaning it is now impossible to obtain?
    Why are there now fewer employees in workplace pension schemes since records began? And why do you consider this a successful outcome from your time as head of UK regulation?

  • pavlaki

    There is an argument that cutting interest rates as low as they have has harmed savers and the ‘grey pound’. These people are quick to reign in their spending which hits the service economy in particular and also delays capital purchases such as new furniture, cars etc. The spending power of ‘savers’ is considerable and they will not feel comfortable until they see their income (through higher rates) rise at which point they will resume spending and help the economy. Cutting rates further may be killing the golden goose.

  • anteos

    Hi Shaun

    where exactly do we stand with the QE money. Is it officially recognised as a debt? Or not as its only ‘temporary’ and will be reversed at some point ;-)

    thanks

  • Anonymous

    Shaun – a fascinating insight. If he was indeed “setting out his stall” then he has succeeded in what the Australians call “dog-whistle politics” where whoever reads or hears the words can take from it exactly what they want, thus appealing to more people. As a strategy, fine, but if this is what he REALLY believes, we are in for more tough, unpalatable medicine!

  • jan

    What about “moral hazard” or does this only apply to us mere mortals? We would all spend like crazy if we didn’t have to pay our debts.
    On another topic, what happened to the Tobin Tax which Lord Turner was in favour of? I believe it has been adopted by some of the EU member states why not us as well?

  • Anonymous

    In fairness it was Gordon Brown who skimmed a new tax out of the pension pots. Gordon Brown also favoured means tested benefits which was another disincentive to save.

    Yes the FSA could have tried to promote more accountability in public companies – directors rewarding themselves for failure is dishonest and economically damaging. Likewise the bankers were too busy taking big bonuses to be bothered doing share value promoting shareholder activism. The FSA could and should have capped mortgages at 95% LTV – allowing 120% LTV is grossly irresponsible.

    The FSA have done little to justify their salaries, but I think the pension enrolment drop was caused by Gordon.

  • Anonymous

    Shaun,

    Thoughts of negative interest rates when energy prices currently increasing at 8 -9% shows how broken the financial linkages are and how out of touch is the BoE and MPC!
    As discussed before energy inflation certainly has a multiplier effect on the UK inflation rates.

  • james

    Shaun,
    Great article as ever. Id say that Lord Turner has the nomination sewn up:
    1. He has magically found a way of reducing government debt
    2. It does not involve cuts or extra tax
    3. It will be done in a way which no-one will understand
    4. Its effects will be indirect and poorly understood by the media
    5. It could be repeated whenever we run out of cash.
    I nearly wept when Robert Peston called all this “accounting” on the radio this morning. We seem to get further and further from the idea that government expenditure should bear some relationship to the tax base. There seems to be no link at all between the real world and that of high finance, whether City or government.
    Today we have seen striking examples of the difference between reality and the crazy world inhabited by people in high office:
    1. Nick Clegg cannot face more welfare cuts, but has not one suggestion as to how to mend the finances of the country (mansion taxes are not going to do it, Nick)
    2. The EU gets the Nobel peace prize. I guess that this is the arch example of one unelected quango giving an abstract entity a prize. Did they take into account the utter failure of the EU to deal with the USSR in the Cold War, the inability to deal with ex-Yugoslavia, Palestine etc etc? There has been no war in Europe because the USA stood up to the USSR, because the USA funded the Marshall plan, because the USA gave the Germans a very constrictive constitution etc. Does the EU have an army in the USA to help keep peace? I thought not. Does the USA still have an army in Germany? I think so.
    3. Lord Turner is being considered for a job when the mistakes he previoulsy made should make him instantly a non candidate. Mind you, Hector Sants was being considered for the Bank of England Court as well, which defies all belief.

  • Robert S

    Shaun,

    Are you able to explain to a non-economist like me, why the £365 billion QE money isn’t creating higher inflation now (I’m assuming the QE money is in the banks hands as I’m guessing the BoE bought the gilts from them), and why it will create inflation when the recovery really kicks off?

    Thank you.

    Robert S

  • Patrick, London

    Call me a cynic, but… because the figures for inflation are being mis-reported all the time…?

  • Patrick, London

    Agree with all of what you say apart from the 95%. If you need a 95% mortgage, you’re not ready, and most likely, not capable of paying a mortgage on which you were only able to raise a 5% deposit. All it does is facilitate overpriced housing.
    Probably, sensible sized deposits/LTVs wouldn’t have stopped the asset rich from continuing their gorging on BTL, but perhaps the market would’ve been cooler, and therefore less attractive. (And the self cert 100% and above legions would’ve been shown the door).

    Has there ever been a debate on taxation on ‘boom’ price increases being separate from standard capital gains. Maybe you could finally eradicate boom and bust in the property market, if you knew that price rises that happened as a result of inflation or speculation were taxed at 80%, as opposed to rises based on ‘gentrification’ of an area, or improvements in the home which were tax free. Obviously a bugger to police, and I haven’t really thought it through, but it seemed an interesting idea a few minutes ago… :)

  • Anonymous

    Yes the LTV upper limit could be lower than 95% – that is a discussion the FSA & BOE should be having. With a 95% mortgage, you need a lot more than the 5% downpayment – lawyers fees, various search fees, stamp duty etc. Possibly money for furniture, basic appliances (Fridge etc) and so on.

    The BTL is driven by a lack of other good investments – see comments about poor deals for minority shareholders, pension funds being retrospectively taxed and pathetic returns for savers. Add to this a residential property shortage and you will get very high prices.

    In hindsight, higher interest rates from 1996 would have kept house prices lower, especially if the BTL generation found returns on savings more profitable than BTL.

  • Anonymous

    Hi Andy
    As to bank regulation there was also the issue of produtcs similar to PPI for business loans which were as bad if not worse. I was involved for a while in the small business sector area and they were definitely pressurised to take out such products with loans.
    You would think that such products involved sales commission which allowed staff to hit targets which if they did not hit they would be sacked over aka enormous moral/financial pressure which the FSA “missed”.

  • Anonymous

    Yes it is.

  • Anonymous

    Hi Patrick
    As you say the problem would be defining it or policing it.
    If you head in that direction the only way of doing it would be to remove/reduce the Capital Gains Tax exemption that a first home has.
    Perhaps you could do it for future gains to try to limit such issues in the future but again that is not easy to define/police.

  • Anonymous

    Hi anteos
    Depends what you mean by debt. If I answer that in terms of the UK public-sector then the national debt numbers as of now are unaffected by it because it is expected to be reversed. That has been the route taken by the Office for National Statistics.
    Should it be “cancelled” then our national debt would shrink by that amount.

  • Anonymous

    Hi Jan
    As of mid-week 11 EU states voted to push the financial transactions tax or Tobin Tax forwards. The problem for us is that we have such a big financial sector and so it would be a drag on that. The issue to my mind is that it is indiscriminate rather than weeding out the bad bits.

  • Anonymous

    Hi Robert
    In essence it is down to human behaviour.
    People change in the two arenas. Right now there will be saving and reductions in borrowing. In a boom/recovery we tend to spend (often too much).
    So just as the economy is doing well we will see that the extra cash is then much more likely to be spent…
    It is in many ways irrational but human beings often are irrational.