Policy response (updated)
Tax rebates for corporates & households, zero interest rates on mortgage and corporate loan refinancing, no debt capital repayment, targeted lending & QE, dual rates, yield capping in the Eurozone – there is lots that both monetary and fiscal authorities can and should do.
This is an updated version of my prior post on the same issue: how should the authorities respond to the extreme recession which has hit our economies? There are already lessons which have been evident for some time, which are not being heeded in the response we are seeing. I want to focus on these, but also add some additional measures which fit the criteria of good policy in the current environment.
A pre-requisite for a good counter-cyclical policy, and this has never been more true, is that the support arrives quickly. A second measure is that it can be adjusted and changed with equal alacrity. When we consider the pros and cons of monetary and fiscal policy – as currently designed – an obvious advantage of monetary policy is the speed of decision-making and impact. The advantage of fiscal policy is that it can impact demand directly and without the complex intermediation (of asset prices, lending) of monetary policy. For precisely these reasons, monetary policy should be reformed to impact incomes more directly, and fiscal policy should be reformed to be more immediately responsive (beyond existing automatic stabilisers). Broadly, policy economists have wasted the last decade in not doing this, when it was clearly needed. We now have a widespread clamour for helicopter money – cash transfers to households from central banks – and no infrastructure in place to deliver it.
The failure of contingency-planning for a recession is unacceptable. But it is where we are. A global pandemic creates a fresh challenge – it is no time to require of any stimulus significant administrative burden, or new systems. Civil servants and central bank staff are also struggling with the challenges of lockdown and illness, as are commercial bank staff.
For precisely these reasons, we need a large-scale policy response which requires no new forms, no phone calls to banks, and no new systems to administer. Sufficient support can in fact be delivered within a matter of days.
My main policy recommendation has been to use tax rebates for precisely this reason. We should rebate personal and corporate taxes. If, for example, the government rebates three year’s worth of corporate taxes (equivalent in the UK to approximately 9% of GDP), in the next three to six month, not a single form needs to be completed. Likewise for households. For households it would make sense to do this for all tax brackets, bar the highest income earners. It is very important to stress that the objective here is not distributional perfection – quite clearly. Some firms – those that haven’t paid tax, for example – will not benefit. Some firms that don’t need cash will receive it. But this misses the point. If we want to avoid a devastating recession we need simple, immediate support. The measure of policy is the counterfactual, not theoretical optimality.
The key strength of tax rebates or revenue rebates, which could be considered for the self-employed or very small businesses, is that no form-filling is required, no applications, no new data. The inland revenue should implement policy based on information it already has. The only requirement may be for households and some businesses to provide bank account details, which can be done by email. Imagine it like this: a letter arrives from the revenue, ‘Apologies we made an error on the last three years of your tax return, please provide us with updated bank details so you can be refunded.’
The Bank of England’s new TFS schemes, deserve applause, but I am concerned about ease of implementation and the scale of impact. There is a strong case for a far simpler approach. Reprice all significant lending across the economy to zero interest rates and suspend all principal or capital repayment. This can be done immediately and solves many problems in one simple policy.
By repricing all outstanding mortgages, and existing corporate loan facilities at zero interest rates and suspending any capital repayment for three months initially and with a view to extending to six months if necessary, there will be zero defaults. Zero defaults means zero capital impairment. No form filling is required. No visits to banks, or six hours waiting on the phone to speak to a bank official who doesn’t understand how a new scheme works or if you are eligible.
Furthermore if central banks do want to do genuine helicopter drops – ie cash transfers to households – without any new infrastructure, the obvious way is to reprice mortgages at negative interest rates. Households will receive a check for their mortgage. This could even be extended to credit card debt. Again, bank profitability can be compensated with tiered reserves.
There is of course a simple cost to repricing all loans to zero for three to six months (by all loans, I mean all household mortgages and all existing corporate loan facilities), the commercial banks lose most of their interest income. There is a very simple way to compensate this. The Bank of England should join the global central banking system and introduced tiered reveres. In simple terms, bank reserves which are created by QE, are separated into require reserves which are remunerated at one interest rate and ‘free’ reserves which are paid an interest rate equivalent to that which the central bank is trying to target the money market rate. The BoE can then pay an interest rate on required reserves at a level which compensates banks for, say, 95% of their foregone interest income – or whatever is necessary to preserve reasonable profitability.
Finally, some clarification about how this is being paid for and the effects on public sector finances. I suspect we will require budget deficits in the range of 10%-30% of GDP over the next six to 12 months. We are however very fortunate. Real interest rates across the yield curve are negative throughout the developed world, which provides huge capacity. And secondly, all the evidence we have is that most of the QE which has occurred over the last decade is to all practical intents and purposes, permanent, which means our starting point levels of net debt were in fact far lower than our national statistics suggest. In other words, most of the public sector debt created since the financial crisis has been bought back by the central bank, so on a net basis, there has been no increase in public sector debt. Yes, austerity was a double-fraud.
Equally important, when our economies recover, and this is an equitable counterpart to the stimulus, we can of course – if needed – raise taxes.
In conclusion, we must act with huge ambition in terms of the scale of support, but with simple and direct policies. Otherwise, administrative failure and overloading will neuter the best of intentions.
The typical response I have seen to many policy responses is ‘but what about X?’, where X is a group which also needs support but is not covered by the proposal. No policy that I am aware of is perfectly targeted and immediate. Nor should it have to be. My response to this is simple: put forward a separate policy to support X.
It should be clear that these policy proposals are not exhaustive. They need to be supplemented with targeted solutions to the many other areas of our economies in need of support. Here is a selection of some great work being done.
Resolution foundation, No Work, No pay
Positive Money EU, Helicopter money as a response to the Covid-19 recession
Claudia Sahm at Equitable Growth
IPPR. Mark Blyth and I have also outlined a structure for corporate support. Beyond bailouts.
Autonomy. Jo Michell and Rob Jump, Guaranteeing incomes: modes of delivery.