YES—Adair Turner:
Nothing is ever quite black and white, and the Covid-19 crisis has shown that central banks still have an important role in liquidity provision: extending loans to commercial banks for on-lending to small- and medium-sized enterprises could prevent some avoidable bankruptcies.
But if we focus on monetary policy, the Covid-19 crisis will confirm that when a major shock threatens the world economy, central banks acting alone are now almost powerless to stimulate nominal demand and economic growth, or to stop inflation falling below target.
The impotence of central bank monetary policy has been increasingly obvious since the global financial crisis of 2008. In the aftermath of that shock, central banks across the world cut interest rates close to or even below zero, but the impact on investment or consumption was limited because overleveraged companies and households were unwilling to borrow even at rock bottom rates.
Central banks then used quantitative easing to drive down long-term yields in line with short-term policy rates, but again the impact on real business investment was minimal: when companies can already borrow at historically low rates, cutting the interest rate further makes little difference to capital expenditure plans.
In February 2016, the Economist magazine had a front cover showing a central banker holding a bazooka but with the title “Out of ammo?” Contrary to that gloomy message, global growth recovered in the following two years. But the reason was massive fiscal expansion in both China and the US, not a sudden rediscovery of monetary policy mojo.
That recovery has been killed by Trump’s trade wars and Covid-19; and faced with a rapid slow down, further rate cuts will have minimal economic impact. Only significant fiscal stimulus can support the economy amid this crisis: and the most important role for central banks will likely be a supporting one, providing monetary finance for increased fiscal deficits.
NO—Paul Tucker:
Everything about central banks stems from their liabilities being the economy’s basic money. That gives them a whole range of tools, which are warranted and effective in different circumstances, and sometimes as you say ineffective.
We need to distinguish measures taken to steer aggregate spending in the economy (monetary policy) from measures to help the economy function at all, at the level of financial intermediaries, regular businesses and households (liquidity support). The scope for the first has been limited for some time now, whereas the second might need to come into its own, maybe in dramatic ways.
So, I am with you that monetary policy cannot maintain growth at a decent pace when businesses cannot open or supply chains are badly and persistently disrupted. Nor can it do so when people are too nervous to spend (which, big picture, is what happened here during the 2011/12 euro area crisis, and why the Bank of England’s monetary stimulus regained traction, bringing about recovery during 2013, after Mario Draghi’s famous intervention lifted the crisis on the other side of the Channel).
All that would be true even if interest rates were not close to zero, which of course they are. That’s been so for years but, for some reason, the UK has been behind other countries in debating how macroeconomic policy should operate if it persists. Let’s come back to that in another round.
But as liquidity providers, central banks are not remotely out of ammunition. They can provide liquidity to banks short of funds but fundamentally sound. Or act as a market maker of last resort to help sound markets function (back when we were in office, I gave a speech setting out principles for that in 2009). Or they can help, directly or indirectly via banks, any businesses or households which the government wants to support. But this needs to be in a wider government response to a partly frozen, almost war-like economy.
So, all told, not what they were a decade ago, never capable of healing hits to the economy’s productive capacity, but not impotent and, right now, with lots lying ahead.
YES—Turner:
We are in danger of agreeing too much. I agree that central bank liquidity operations are still important: and you agree that monetary policy is powerless in the face of Covid-19.
But the reduced potency of monetary policy is a deep and long-lasting phenomenon, not just a product of circumstances in which “businesses cannot open or supply chains are badly disrupted.”
Gradually over 30 years, we have seen a huge fall in equilibrium interest rates, with real yields on long-term index-linked gilts and US Treasury bonds falling from around 4 per cent in 1990 to negative today. This reflects the structural changes which Larry Summers and Lucasz Rachel explore in a recent paper.
Demographic trends and rising inequality are increasing attempted ex-ante savings rates: technological change is reducing intended private investment. Private sector financial balances will therefore produce secular stagnation—long-term sluggish growth in the economy—unless offset by large and continuous fiscal deficits.
The canary in the mine was Japan, which western economists too long assumed was globally irrelevant because so specifically Japanese. For 30 years its short-term interest rates and long-term government bond yields have been close to zero: it runs large fiscal deficits year after year and gross government debt continually increases; but since the Bank of Japan continually buys government bonds, the net debt level of the consolidated public sector does not rise.
Governor Kuroda continues to pretend that his large bond purchases are monetary policy operations, stimulating the economy via an interest rate effect, and due to be reversed when normality returns and the bonds are sold back to the private sector. But in fact this is permanent monetary finance, enabling a fiscal stimulus which is essential to Japanese economic growth.
The Covid-19 crisis has exposed the structural reality which will remain even when economies recover. In macroeconomics, we face structurally different conditions than applied 20 years ago: but theories and policy practices have not yet adjusted in the face of this new reality that central banks are in key respects increasingly powerless.
NO—Tucker:
Demographic changes mean people want to save more. More disturbingly, persistently subdued productivity growth, possibly predating 2007/08, means that nations are poorer than expected. Central bankers cannot cure this, but must incorporate the effects into their forecasts. (Incidentally, that means it is inconsistent with independence for a central bank chief economist to lead a government’s work on productivity, as now, because the monetary committee has to reach its own view on whether government measures will work.)
But impotence to change long-term prospects with monetary instruments is not the same as impotence to stabilise the economy cyclically, which you are claiming. If the second has arisen, it was not an inevitable consequence of adverse structural developments in the real economy but results from how they bite when combined with the parameters of the monetary regime; in particular, the low steady-state target for inflation of 2 per cent. If it had been higher (for illustration only, say 5 per cent), then the average rate of interest would have been higher in money terms, leaving more scope to cut rates to help get through a normal recession.
That’s why it has been urgent—for some years!—that the framework be reviewed. I have absolutely no preconceived conclusions, but while politicians were preoccupied with Brexit, unelected policymakers had an opportunity to focus on their own biggest challenge. Central banks probably could have been better equipped.
Now there are graver issues. If Covid-19 persists, government debt could skyrocket: around WW2, it was roughly 200 per cent of GDP. Who buys UK, US, French debt matters, geopolitically (I am writing a book on this subject). The options are: potentially unfriendly foreigners, friendly foreigners, domestic investment institutions, banks and the central bank. Domestic currency and domestically-held debt would help avoid the prospect down the road of an ugly conflict with powers less friendly than the US was to Britain in 1946. This reframes your “helicopter money” as an existential choice, and it belongs with our elected legislators.
So, central banks are not impotent on vital liquidity support, need not be on macroeconomic stabilisation, but I agree cannot solve the deepest problems our economies and societies face.
YES—Turner:
We agree that central bankers cannot cure structural challenges such as low productivity. Central banks should focus on financial system liquidity and the level of aggregate nominal demand, while fiscal authorities in addition address issues of economic efficiency and income distribution.
But your argument that monetary policy would have retained potency if inflation targets had been higher avoids today’s reality. Suppose we now reset inflation targets to 5 per cent, how would we achieve them? Kenneth Rogoff, the former IMF chief economist now at Harvard, argues that if only we abolished paper cash and coins, we could set interest rates at dramatically negative levels—let’s say at minus 4 per cent. But in the real world, that would provoke deflationary withdrawal of money from the banking system.
So when interest rates are already close to a zero or mildly negative lower bound, the only way to achieve even a 2 per cent inflation target, let alone one still higher, is fiscal stimulus.
The question is how to finance the large fiscal deficits which will result: do we keep issuing bonds to the private sector, even if debt to GDP rises to the +200 per cent levels seen at the end of World War Two or in Japan today?
Or should we use monetary finance to stimulate nominal demand without increasing debt to GDP? As I described in Between Debt and the Devil it’s undoubtedly technically possible: so the key question is how to use it in a disciplined fashion, avoiding the delusion that we have found a limitless money tree which can cure structural as well as demand problems.
In April 2016, ex-Fed chair Ben Bernanke proposed that independent central banks should have the authority to decide how much monetary finance is appropriate, while fiscal authorities of course decide how the money is spent. That would give central banks an important role in macro demand management. Without it, they are powerless to influence demand in a world beset by structural stagnation and a huge economic shock.
NO—Tucker:
On our essay question—are central banks now impotent?—the answer is plainly no: there are plenty of potent things they can still do. On whether regular monetary policy is now impotent, the answer is almost, but it need not have been that way. That matters because there needs to be some public accounting for the predicament. (Just as there should be on the financial system entering the current crisis with avoidable degrees of leverage and fragility in trading markets.)
I agree the burden of macroeconomic stabilisation will fall on fiscal policy. On its financing, governments should not resort to the printing press when they could use debt and taxes. Acting as market maker of last resort, as the Bank used to, could help keep the government debt market open, and so monetisation at bay.
Monetisation is for when debt is on an explosive, unsustainable course or, as flagged above, exposing a state to existential crisis. That momentous decision is properly for legislators because it is a form of taxation ( Unelected Power), is hard to reverse, and the eventual remedy is fiscal.
On retaining a role for central bankers, the Bernanke idea you mention needs to cater for when the central bank thinks it is time to stop or cut back but the government does not want to. Remember US president Truman accused the Fed of treason when, in the early 1950s, it wanted to stop pegging bond yields.
I agree about learning from Japan—an economy with unsustainable debt that is largely held domestically, which is in the ante-room of monetisation, but where inflation has not rekindled. Maybe it would have been better openly to suspend independence, rather than just eroding it.
But if a central bank’s independence were suspended, the still-potent liquidity support role would also be politicised, the government could spend on what it liked without legislative control—both bad things—and policymakers would need an exit plan. Weighty decisions lie ahead.
Adair Turner was chairman of the Financial Services Authority and is now chairman of the Institute for New Economic Thinking
Paul Tucker was a deputy governor of the Bank of England and is now a research fellow at the Harvard Kennedy School, and the author of "Unelected Power" (Princeton)
Nothing is ever quite black and white, and the Covid-19 crisis has shown that central banks still have an important role in liquidity provision: extending loans to commercial banks for on-lending to small- and medium-sized enterprises could prevent some avoidable bankruptcies.
But if we focus on monetary policy, the Covid-19 crisis will confirm that when a major shock threatens the world economy, central banks acting alone are now almost powerless to stimulate nominal demand and economic growth, or to stop inflation falling below target.
The impotence of central bank monetary policy has been increasingly obvious since the global financial crisis of 2008. In the aftermath of that shock, central banks across the world cut interest rates close to or even below zero, but the impact on investment or consumption was limited because overleveraged companies and households were unwilling to borrow even at rock bottom rates.
Central banks then used quantitative easing to drive down long-term yields in line with short-term policy rates, but again the impact on real business investment was minimal: when companies can already borrow at historically low rates, cutting the interest rate further makes little difference to capital expenditure plans.
In February 2016, the Economist magazine had a front cover showing a central banker holding a bazooka but with the title “Out of ammo?” Contrary to that gloomy message, global growth recovered in the following two years. But the reason was massive fiscal expansion in both China and the US, not a sudden rediscovery of monetary policy mojo.
That recovery has been killed by Trump’s trade wars and Covid-19; and faced with a rapid slow down, further rate cuts will have minimal economic impact. Only significant fiscal stimulus can support the economy amid this crisis: and the most important role for central banks will likely be a supporting one, providing monetary finance for increased fiscal deficits.
NO—Paul Tucker:
Everything about central banks stems from their liabilities being the economy’s basic money. That gives them a whole range of tools, which are warranted and effective in different circumstances, and sometimes as you say ineffective.
We need to distinguish measures taken to steer aggregate spending in the economy (monetary policy) from measures to help the economy function at all, at the level of financial intermediaries, regular businesses and households (liquidity support). The scope for the first has been limited for some time now, whereas the second might need to come into its own, maybe in dramatic ways.
So, I am with you that monetary policy cannot maintain growth at a decent pace when businesses cannot open or supply chains are badly and persistently disrupted. Nor can it do so when people are too nervous to spend (which, big picture, is what happened here during the 2011/12 euro area crisis, and why the Bank of England’s monetary stimulus regained traction, bringing about recovery during 2013, after Mario Draghi’s famous intervention lifted the crisis on the other side of the Channel).
All that would be true even if interest rates were not close to zero, which of course they are. That’s been so for years but, for some reason, the UK has been behind other countries in debating how macroeconomic policy should operate if it persists. Let’s come back to that in another round.
But as liquidity providers, central banks are not remotely out of ammunition. They can provide liquidity to banks short of funds but fundamentally sound. Or act as a market maker of last resort to help sound markets function (back when we were in office, I gave a speech setting out principles for that in 2009). Or they can help, directly or indirectly via banks, any businesses or households which the government wants to support. But this needs to be in a wider government response to a partly frozen, almost war-like economy.
So, all told, not what they were a decade ago, never capable of healing hits to the economy’s productive capacity, but not impotent and, right now, with lots lying ahead.
YES—Turner:
We are in danger of agreeing too much. I agree that central bank liquidity operations are still important: and you agree that monetary policy is powerless in the face of Covid-19.
But the reduced potency of monetary policy is a deep and long-lasting phenomenon, not just a product of circumstances in which “businesses cannot open or supply chains are badly disrupted.”
Gradually over 30 years, we have seen a huge fall in equilibrium interest rates, with real yields on long-term index-linked gilts and US Treasury bonds falling from around 4 per cent in 1990 to negative today. This reflects the structural changes which Larry Summers and Lucasz Rachel explore in a recent paper.
Demographic trends and rising inequality are increasing attempted ex-ante savings rates: technological change is reducing intended private investment. Private sector financial balances will therefore produce secular stagnation—long-term sluggish growth in the economy—unless offset by large and continuous fiscal deficits.
The canary in the mine was Japan, which western economists too long assumed was globally irrelevant because so specifically Japanese. For 30 years its short-term interest rates and long-term government bond yields have been close to zero: it runs large fiscal deficits year after year and gross government debt continually increases; but since the Bank of Japan continually buys government bonds, the net debt level of the consolidated public sector does not rise.
Governor Kuroda continues to pretend that his large bond purchases are monetary policy operations, stimulating the economy via an interest rate effect, and due to be reversed when normality returns and the bonds are sold back to the private sector. But in fact this is permanent monetary finance, enabling a fiscal stimulus which is essential to Japanese economic growth.
The Covid-19 crisis has exposed the structural reality which will remain even when economies recover. In macroeconomics, we face structurally different conditions than applied 20 years ago: but theories and policy practices have not yet adjusted in the face of this new reality that central banks are in key respects increasingly powerless.
NO—Tucker:
Demographic changes mean people want to save more. More disturbingly, persistently subdued productivity growth, possibly predating 2007/08, means that nations are poorer than expected. Central bankers cannot cure this, but must incorporate the effects into their forecasts. (Incidentally, that means it is inconsistent with independence for a central bank chief economist to lead a government’s work on productivity, as now, because the monetary committee has to reach its own view on whether government measures will work.)
But impotence to change long-term prospects with monetary instruments is not the same as impotence to stabilise the economy cyclically, which you are claiming. If the second has arisen, it was not an inevitable consequence of adverse structural developments in the real economy but results from how they bite when combined with the parameters of the monetary regime; in particular, the low steady-state target for inflation of 2 per cent. If it had been higher (for illustration only, say 5 per cent), then the average rate of interest would have been higher in money terms, leaving more scope to cut rates to help get through a normal recession.
That’s why it has been urgent—for some years!—that the framework be reviewed. I have absolutely no preconceived conclusions, but while politicians were preoccupied with Brexit, unelected policymakers had an opportunity to focus on their own biggest challenge. Central banks probably could have been better equipped.
Now there are graver issues. If Covid-19 persists, government debt could skyrocket: around WW2, it was roughly 200 per cent of GDP. Who buys UK, US, French debt matters, geopolitically (I am writing a book on this subject). The options are: potentially unfriendly foreigners, friendly foreigners, domestic investment institutions, banks and the central bank. Domestic currency and domestically-held debt would help avoid the prospect down the road of an ugly conflict with powers less friendly than the US was to Britain in 1946. This reframes your “helicopter money” as an existential choice, and it belongs with our elected legislators.
So, central banks are not impotent on vital liquidity support, need not be on macroeconomic stabilisation, but I agree cannot solve the deepest problems our economies and societies face.
YES—Turner:
We agree that central bankers cannot cure structural challenges such as low productivity. Central banks should focus on financial system liquidity and the level of aggregate nominal demand, while fiscal authorities in addition address issues of economic efficiency and income distribution.
But your argument that monetary policy would have retained potency if inflation targets had been higher avoids today’s reality. Suppose we now reset inflation targets to 5 per cent, how would we achieve them? Kenneth Rogoff, the former IMF chief economist now at Harvard, argues that if only we abolished paper cash and coins, we could set interest rates at dramatically negative levels—let’s say at minus 4 per cent. But in the real world, that would provoke deflationary withdrawal of money from the banking system.
So when interest rates are already close to a zero or mildly negative lower bound, the only way to achieve even a 2 per cent inflation target, let alone one still higher, is fiscal stimulus.
The question is how to finance the large fiscal deficits which will result: do we keep issuing bonds to the private sector, even if debt to GDP rises to the +200 per cent levels seen at the end of World War Two or in Japan today?
Or should we use monetary finance to stimulate nominal demand without increasing debt to GDP? As I described in Between Debt and the Devil it’s undoubtedly technically possible: so the key question is how to use it in a disciplined fashion, avoiding the delusion that we have found a limitless money tree which can cure structural as well as demand problems.
In April 2016, ex-Fed chair Ben Bernanke proposed that independent central banks should have the authority to decide how much monetary finance is appropriate, while fiscal authorities of course decide how the money is spent. That would give central banks an important role in macro demand management. Without it, they are powerless to influence demand in a world beset by structural stagnation and a huge economic shock.
NO—Tucker:
On our essay question—are central banks now impotent?—the answer is plainly no: there are plenty of potent things they can still do. On whether regular monetary policy is now impotent, the answer is almost, but it need not have been that way. That matters because there needs to be some public accounting for the predicament. (Just as there should be on the financial system entering the current crisis with avoidable degrees of leverage and fragility in trading markets.)
I agree the burden of macroeconomic stabilisation will fall on fiscal policy. On its financing, governments should not resort to the printing press when they could use debt and taxes. Acting as market maker of last resort, as the Bank used to, could help keep the government debt market open, and so monetisation at bay.
Monetisation is for when debt is on an explosive, unsustainable course or, as flagged above, exposing a state to existential crisis. That momentous decision is properly for legislators because it is a form of taxation ( Unelected Power), is hard to reverse, and the eventual remedy is fiscal.
On retaining a role for central bankers, the Bernanke idea you mention needs to cater for when the central bank thinks it is time to stop or cut back but the government does not want to. Remember US president Truman accused the Fed of treason when, in the early 1950s, it wanted to stop pegging bond yields.
I agree about learning from Japan—an economy with unsustainable debt that is largely held domestically, which is in the ante-room of monetisation, but where inflation has not rekindled. Maybe it would have been better openly to suspend independence, rather than just eroding it.
But if a central bank’s independence were suspended, the still-potent liquidity support role would also be politicised, the government could spend on what it liked without legislative control—both bad things—and policymakers would need an exit plan. Weighty decisions lie ahead.
Paul Tucker was a deputy governor of the Bank of England and is now a research fellow at the Harvard Kennedy School, and the author of "Unelected Power" (Princeton)
