We live in a era where monetary policy is more transparent than ever – if measured by press conferences, publication of minutes and individual policy-makers forecasts.
At the same time, the behaviour of central banks has never been less clear.
Any discussion of the theoretical and practical details of global monetary policy reveals very quickly that even most specialists in the area don’t really understand what’s going on. If you are in any doubt, try asking any macro-economist these two questions: ‘Is the ECB’s TLTRO programme ‘fiscal policy’?’ or ‘Is the Bank of Japan’s introduction of tiered reserves ‘helicopter money’?’ Many will need to double-check what the TLTRO is, and take a refresher course on tiered reserves. Even then, most answers approximate jibberish (I’ll omit citations).
We are now in a world where behind superficial transparency hides extreme obfuscation. This is harmful and unnecessary. Global central banking, like many areas of the body politic, is crying out for serious leadership.
Let me go straight to the punchline: central banks have the tools to solve the shortfall in global demand, they are currently using these tools, but doing so in a half-hearted, opaque and ineffective fashion, while pretending that they are not.
If you are in any doubt about this read three of best macroeconomists in the world, who understand the detail, know about history, and can explain almost any monetary acronym you throw at them: Brad DeLong, Simon Wren-Lewis and Martin Sandbu. Wren-Lewis highlights the extent of current confusion in this dissection of the Bank of England’s recent decision: the Bank simultaneous jokes about the absurdity of doing helicopter money and announces a variant of it (hidden behind the acronym, TFS). The FT’s Martin Sandbu makes a similar point with equivalent incisiveness. Brad DeLong on his go-to website on all matters economic (and many other matters, too) has written about and referenced all these issues.
Ok, so how can central banks raise global demand? In the simplest terms: they have to be wiling to make (accounting) losses. Now before you switch off and say ‘forget it’, or, if you’re a pedant, ‘that’s fiscal policy’, let’s be absolutely clear: they’ve already started, and worse than that they are exposing themselves to losing a lot more than is necessary in a completely ham-fisted and ineffective way. Economists need to focus on this, and escape the pedantry and theoretical blind alleys we have become obsessed with.
Lose money effectively
A little-commented on fact is that up until recently, QE has been hugely profitable (in simple accounting terms) for central banks. The reason is straightforward: they buy bonds yielding more than they pay on the reserves they create to buy the bonds. Now if CBs are able to make huge profits in pursuit of monetary goals, they can make large losses. In fact due to the colossal bond buying programmes of the BoE, BoJ, Fed and ECB, if bond yields go anywhere close to levels of, say, 3% or 4% these central banks will suffer huge accounting losses. In fact, this is what they want – bond yields rising would signal a strong recovery in global demand. Making a perpetual loan to households equivalent to 1% of your balance sheet runs less risk of loss than buying 20-year JGBs or Bunds equivalent to 10% of your balance sheet, when you expect to lose 10% (and could lose a lot more). Furthermore the BoJ has already overridden any squeamishness about creating or buying assets at yields below the interest rate on reserves it is paying. It has purchased JGBs at negative yields, while remunerating most of the reserves created at zero interest rates.
So let’s be honest, central banks are either willing to lose money, in the sense of creating negative net interest income, or in exposing themselves to significant expected capital losses. If there’s a taboo, it was breached a long time ago. Also, let’s be clear, it’s a silly taboo – central banks ‘losing money’ to meet inflation targets is precisely what they are supposed to do. It’s accounting nonsense, based on treating the monetary authorities like private banks. They’re not: the benefits of creating money to raise demand show up as an externality – nothing less than higher living standards! Another way to make the same point is to recognise that bank reserves are not liabilities in any meaningful sense. Moreover, the technicalities of dealing with more reserves than we need – the only thing that matters on a CBs balance sheet – can be easily dealt with.
So the problem is not about central banks losing money, it is the complete lack of transparency: a huge exposure to losses is being created, and transfers through money printing is occurring by stealth – all without materially increasing demand. Surely we can do better.
It is in fact very clear what needs to be done. We need to crystallise the ‘losses’ up front (or make perpetual loans so the accounting is appropriately redundant): central banks need to make transfers direct to the household sector. We should do this transparently, and fairly. Many of us, from across the political and theoretical spectrum, have outlined how: Brad DeLong, Simon Wren-Lewis & Mark Blyth, Adair Turner, Lord Skidelsky, Matthew Klein, Steve Keen, Frances Coppola, Martin Wolf, and many others. The empirical evidence that these policies work – and require the printing of far less money – is more compelling than for any current policy ‘innovations’ such as extending QE to the corporate bond market or negative interest rates.
Now, some members of the economics profession are up in arms: ‘this is fiscal policy!’, ‘central banks have too much power!’, ‘Zimbabwe!’, ‘everyone will panic!’. Well, we already are doing this – it’s just completely obscured, largely ineffective, and with random (or highly skewed) distributional consequences. And no one is panicking. No one is making a serious case that it’s illegal. The ECB arguably strayed way beyond its constitutional legal mandate in Greece and Ireland, but transfers to households are entirely legal, and subject to its independence and the absence of fiscal intervention, arguably a legal obligation. So these arguments are already redundant. A point Karl Whelan professor of economics at UCD, and former Fed economist, makes very lucidly. Central banks are already either making losses, or running the risk of huge accounting losses. That in-of-itself is fine – the only argument is one of efficiency.
The problem is very clearly not the law, potential panic, or hyperinflation – it is a preference for opacity over effectiveness. Argument alone may not win this one, it requires something else: leadership.
This interview from Peter Praet, executive board of the ECB is the exception that proves the rule – an honest appraisal of what all central banks can do if they want to.
This remark from the Bank of England’s Ben Broadbent epitomises the problem. If the Bank of England succeeds in raising demand, which presumably it expects to do, it will make huge accounting losses on its QE programme.
Great article. Many thanks. But when it comes to transparency, I’m a bit confused!
EG you say bank reserves are not liabilities (of the central bank). Do you know of any central banker who agrees with this? Or indeed commercial bankers? They and their accountants sign off on their financial accounts showing that deposits with the central bank (Reserves) exist and have real value as stated in those accounts. Are they signing off fraudulently?
Do you therefore agree with Adair Turner that a country can, with some complex structuring of debt arrangements, carry out deficit spending and not increase its sovereign debt? Does the IMF, who keeps the score on sovereign debt, agree with this? It is really important to sort this out with real world statisticians and accountants. Otherwise we risk a Greek situation.
I recognise that you might say that the IMF statisticians are wrong, but if they say deficit spending increases the debt, and those numbers are used by debt investors, aren’t they the important thing? (I fully agree, by the way, that quoting debt to GDP ratios without saying how much is held domestically versus internationally doesn’t make much sense. They have different risk factors. Is that the point you are really trying to make?)
If observers continue to to say that there is some magic in central banks, where numbers on balance sheets don’t have to add up, traditional accounts can be ignored, wealth can be spirited out of nowhere, spending more than you earn doesn’t increase debt, then I can’t see how anyone will ever feel there is enough transparency in central banking to have faith in what is being done. (And Central Bank Governors are saying they don’t agree with any of this.) What are ordinary people meant to think?
I think there are two channels of discussion. One is where does the money come from. This needs to be clarified or it blurs the second channel. For all of us, the consequences of spending more money than are raised in taxes is pretty crucial.
The second channel is how to spend any money that is available. Should it be on the health service, on infrastructure, on tax rebates, on cash envelopes to individuals? Is it best to stimulate investment or consumer spending etc.
Grateful any thoughts you have on this. Again, a timely article! Transparency is everything!