It’s Wednesday and I usually try to write less blog material. But given the holiday on Monday and a couple of interesting developments, I thought I would write a bit more today. And after that, you still get some great piano playing to make wading through central bank discussions worth while. The Financial Times article (January 4, 2021) – Investors believe BoE’s QE programme is designed to finance UK deficit – is interesting because it provides one more piece of evidence that exposes the claims of mainstream macroeconomists operating in the dominant New Keynesian tradition. The facts that emerge are that the major bond market players do not believe the Bank of England statements about its bond-buying program which have tried to deny the reality that the central bank is essentially buying up all the debt issued by the Treasury as it expands its fiscal deficits. This disbelief undermines many key propositions that students get rammed down their throats in macroeconomics courses. It also provides further credence to the approach taken by Modern Monetary Theory (MMT).
Central bankers caught out
For years now, the ECB Board members have been out there trying to deny the obvious.
Economists have joined in the charade because to admit the obvious would expose the whole scam.
While the Bank of Japan began their large bond-buying exercise in the early 2000s, it wasn’t until the GFC that other leading central banks joined the party.
In Europe, the ECB, faced with the insolvency of many Member States of the Economic and Monetary Union (EMU), moved outside the legal limits of its operations under the various Treaties, and, in May 2010, introduced the Securities Markets Program (SMP) whereby they began buying up unlimited volumes of national government debt in the secondary markets.
They clearly should have done that sooner – back in 2008 – and the European Commission should have immediately suspended the Stability and Growth Pact provisions.
At that time, if the ECB had have announced that they would support all necessary fiscal deficits to offset the private spending collapse things would have been somewhat different for the GFC experience of the 19 Member States.
The former decision could have been justified under the ‘exceptional and temporary’ circumstances provision of Article 126 of the TFEU relating to the Excessive Deficit Procedure.
It was clear that the situation was ‘exceptional’ and with appropriate policy action would have been ‘temporary’. The Council had already demonstrated a considerable propensity to bend its own rules.
However, the ECB’s intervention came too late to curb the damage and was accompanied by moronic conditionalities, which morphed into the oppression dished out by the Troika (ECB, EC and IMF) on Greece and other nations suffering massive recessions.
If the SMP had been introduced in 2008 rather than 2010 and without the conditional austerity attached, things would have been much different.
No Treaty change would have been required for either of these ad hoc arrangements to be put in place.
While obviously inconsistent with the dominant neoliberal Groupthink in Europe, these policy responses would have saved the Eurozone from the worst.
Fiscal deficits and public debt levels would have been much higher but, in return, there would have been minimal output and employment losses and private sector confidence would have returned fairly quickly.
The response of the private bond markets would have been irrelevant.
The fact is though, that the ECB was out there buying up the debt issued by the Member States and suppressing bond yields in the process.
That began in earnest on May 14, 2010 when the ECB established its Securities Markets Program (SMP) that allowed the ECB and the national central banks to, in the ECB’s own words, “conduct outright interventions in the euro area public and private debt securities markets” (Source).
This was central bank-speak for the practice of buying government bonds in the so-called secondary bond market in exchange for euros, that the ECB could create out of ‘thin air’.
Government bonds are issued to selective institutions (mostly banks) by tender in the primary bond market and then traded freely among speculators and others in the secondary bond market.
The action also meant that the ECB was able to control the yields on the debt because by pushing up the demand for the debt, its price rose and so the fixed interest rates attached to the debt fell as the face value increased.
Competitive tenders then would ensure any further primary issues would be at the rate the ECB deemed appropriate (that is, low).
What followed was pure pantomime.
After the SMP was launched, a number of ECB’s official members gave speeches claiming that the program was necessary to maintain, in the words of Executive Board member, José Manuel González-Páramo during a speech delivered on October 21, 2011 – The ECB’s monetary policy during the crisis:
… a functioning monetary policy transmission mechanism by promoting the functioning of certain key government and private bond segments …
In other words, by placing the SMP in the realm of normal weekly central bank liquidity management operations, they were trying to disabuse any notion that they were funding government deficits.
This was to quell criticisms, from the likes of the Bundesbank and others, that the program contravened Article 123 of the TEU.
In early 2011, the fiscally-conservative boss of the Bundesbank, Axel Weber, who was being touted to replace Trichet as head of the ECB, announced he was resigning, ostensibly in protest of the SMP and the bailouts offered to Greece and Portugal.
On October 10, 2010, Axel Weber, a ECB Executive Board member, told a gathering in New York that the SMP was “blurring the different responsibilities between fiscal and monetary policy.”
Another ECB Executive Board member, Jürgen Stark also resigned in protest over the SMP in November 2011. He clearly understood that the ECB was disregarding the no bailout clauses that were at the heart of its legal existence.
The head of the Bundesbank, Jens Weidmann also was critical.
He knew that the SMP was what he erroneously called “monetary financing”.
In a speech given to the SUERF/Deutsche Bundesbank Conference in Berlin on November 8, 2011 – Managing macroprudential and monetary policy – a challenge for central banks – he noted that:
One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the money printing press. In conjunction with central banks’ independence, the prohibition of monetary financing, which is set forth in Article 123 of the EU Treaty, is one of the most important achievements in central banking. Specifically for Germany, it is also a key lesson from the experience of the hyperinflation after World War I. This prohibition takes account of the fact that governments may have a short-sighted incentive to use monetary policy to finance public debt, despite the substantial risk it entails. It undermines the incentives for sound public finances, creates appetite for ever more of that sweet poison and harms the credibility of the central bank in its quest for price stability. A combination of the subsequent expansion in money supply and raised inflation expectations will ultimately translate into higher inflation.
Whatever spin one wants to put on the SMP, it was unambiguously a fiscal bailout package.
Weidmann was correct in that sense.
The SMP amounted to the central bank ensuring that troubled governments could continue to function (albeit under the strain of austerity) rather than collapse into insolvency.
Whether it breached Article 123 is moot but largely irrelevant.
The SMP reality was that the ECB was bailing out governments by buying their debt and eliminating the risk of insolvency.
The SMP demonstrated that the ECB was caught in a bind.
It repeatedly claimed that it was not responsible for resolving the crisis but, at the same time, it realised that as the currency-issuer, it was the only EMU institution that had the capacity to provide resolution.
The SMP saved the Eurozone from breakup.
And, of course, this sort of behavour by central banks is now the norm.
Which is why a recent article in the Financial Times (January 4, 2021) – Investors believe BoE’s QE programme is designed to finance UK deficit – is interesting.
Note that Chris Giles (one of the co-authors of the article and Economics Editor at the FT) has been tweeting about the big U-turn from the OECD (which I will write about soon) supporting fiscal dominance and rejecting almost all of the claims that that organisation pushed for years about the benefits of austerity.
It seems that Mr Giles, one of the leading austerity proponents in the financial media, is also undergoing somewhat of an epiphany, as are many who are desperately trying to get on the right side of history, as the paradigm in macroeconomics shifts towards an Modern Monetary Theory (MMT) understanding.
The FT article relates to the bond-purchasing program of the Bank of England.
In the same way that the ECB officials denied what they were doing, the Bank of England govrnor claims that their massive quantitative easing program is about ‘inflation control’ – pushing inflation up to its 2 per cent target rate.
Of course, even that sort of reasoning reflects the flaws of the mainstream paradigm.
Central banks have proven incapable of driving up inflation rates as they increase bank reserves because the underlying theory of inflation (Quantity Theory of Money with money multiplier) is inherently incorrect.
But the FT article surveyed “the 18 biggest players in the market for UK government bonds” to see what their understanding of what the Bank of England was up to.
The results were:
1. “overwhelming majority believe that QE in its current incarnation works by buying enough bonds to mop up the amount the government issues and keep interest rates low”.
2. “most said they thought the scale of BoE bond buying in the current crisis had been calibrated to absorb the flood of extra bonds sold this year, suggesting they believe the central bank is financing the government’s borrowing.”
3. “investors place fiscal financing at the centre of their understanding of how QE works, a conviction that has strengthened in the current crisis compared with previous rounds of bond buying.”
The FT article provided this graph, which tells the story:
The bottom line is that the bond market players don’t believe a word the Bank of England bosses are saying.
And this bears on the so-called arguments about central bank credibility, used by the mainstream to suppress fiscal policy and central bank bond buying programs.
Apparently, if the bond markets think the way the central bank is behaving is not ‘credible’ then rising yields and inflation will follow quickly as the markets ignore central bank policy settings.
One has to laugh.
Here we clearly have the major players in the bond markets outrightly disbelieving the central bank statements and clearly understanding exactly what the bank is up to, yet yields stay around zero and there is no inflation remotely in sight.
The FT revealed that the survey respondents also did not believe the line pushed by New Keynesians (mainstream macroeconomists) that the Bank bond purchases would drive inflation up.
One respondent said:
While the idea of raising inflation expectations, to help reach the bank’s target of actual inflation, is very popular, it is arguably less clear to what extent central banks can really influence inflation expectations and actual inflation.
The game is well and truly up!
Music – Hymn to Freedom
This is what I have been listening to while working this morning.
It is a piano piece that I like to sometimes play on my own as a sort of practice routine.
1. Ray Brown (Acoustic double bass).
2. Ed Thigpen (Drums).
The whole album is one of the best out there.
Oscar Peterson wrote the song in support of the civil rights movement in the US in the early 1960s.
On the Freedom reference, which isn’t why I was listening to the album today, I saw that Kamala Harris is once again in the spotlight for a story about her childhood where she appears to rip-off an anecdote from Martin Luther King. It doesn’t augur well for the next administration in the US. See this story if you are interested – Kamala Harris’ ‘Fweedom’ story mirrors MLK account (January 4, 2021).
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.