Today, I have read a number of different reports from various organisations (IMF, Bank of England, US mortgage brokers, etc.) keeping up to date with what it going on. It all adds up to a bleak way to spend the day although that is the lot I bear (violins out!) as an economist. Imagine being a dentist though (apologies Martin!). Then you would be really working in confined spaces. My confined spaces are the claustrophobic world of mainstream economics. The economic crisis has really demonstrated how stupid (and evil) this body of theory (and policy) is. Anyway, today’s blog reports on what I have been reading and writing about today – all from a modern monetary theory (MMT) perspective – which is the free-range and sunny world that all economists should migrate too!
The futility of it all …
Yesterday, the Bank of England (I wish they would change their orange logo to blue or something) announced their latest policy position. They decided to maintain the overnight “Bank Rate” at 0.5 per cent and increase the size of the asset purchase programme (a.k.a. as quantitative easing) by a further £25 Billion to £200 Billion.
While the rates decision was expected, the so-called “City” (read business fat cats) were critical of the decision according to this Guardian report which carried the headline “Bank of England extends quantitative easing by £25bn – but is it enough?” The business lobby had been wanting the QE to be extended by a further £50 billion over the next 3 months.
I became agitated as soon as I saw the phrase “but is it enough”. It is too much! Too much an exercise in futility, that is.
The BOE’s statement from its Monetary Policy Committee said that:
In the United Kingdom, output has fallen by almost 6% since the start of 2008. Households have reduced their spending substantially and business investment has fallen especially sharply. GDP continued to fall in the third quarter … The medium-term prospects for output and inflation continue to be determined by the balance between two opposing sets of forces. On the one hand, there is a considerable stimulus still working through from the substantial easing in monetary and fiscal policy … On the other hand, the need for banks to continue the process of balance sheet repair is likely to limit the availability of credit. And high levels of debt will weigh on spending.
So they think that a lack of lending and consumers trying to save is impeding growth. I agree. The channel is via aggregate demand which has fallen so badly in the UK that they have experienced 6 quarters of negative GDP growth (its longest slump in recorded history).
The Guardian reported that:
With the government concerned that the lack of credit to business is hindering Britain’s recovery prospects, the chancellor, Alistair Darling, rubber-stamped the Bank’s permission to increase the size of the asset purchase programme.
Here is the Chancellor’s Letter for your interest. What have been the reactions of the other political parties in the UK?
The The Liberal Democrat Treasury spokesman said that:
The Bank of England clearly thinks that the economy is still a long way from recovery. As the UK is one of the last developed nations to still be in recession and with interest rates already at a record low, the Bank has few options other than extending quantitative easing. While the Liberal Democrats support the principle of quantitative easing, it is clear that as banks continue to hoard liquidity, this money is not feeding through to the wider economy. There is now a danger that we are simply throwing more and more money at a problem with little evidence that it is having any positive impact.
Well I wouldn’t vote for him. He is wrong to support the QE policy but right that they are pursuing a policy which will not deliver the impact they desire.
On the Conservative front, I couldn’t find any response from the Tories but they are pushing for a lifting of the ban on hunting, which they consider to be a “brazen” and “contemptuous” and “relentless …. assault on rural England”. I guess that is probably as far as their capacity to conceive of public interest extends.
To kick things off, I liked the following cartoon in the Guardian overnight by cartoonist Steve Bell.
Anyway as background – you might like to read this blog – Quantitative easing 101 – which provides a comprehensive critique of the economics underlying the policy approach.
Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).
So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.
Proponents of quantitative easing claim it adds liquidity to a system where lending by commercial banks is seemingly frozen because of a lack of reserves in the banking system overall. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system. That is an unfortunate and misleading representation.
Please never use the term “printing money” in polite company. It is such a loaded and inaccurate term. Government spending (including QE transactions) merely credit bank reserves – via electronic delivery. The Guardian put it this way “The Bank of England … slowed the rate of electronic money growth to boost Britain’s moribund economy to £25bn over the next three months”.
The mainstream economists advocate QE once interest rates get down to zero because they see it as the only stimulatory monetary policy measure left. But their conception of the way the monetary system operates is flawed and also reflects their obsession with the use of monetary policy as a counterstabilising policy tool.
Modern monetary theory (MMT) suggests that monetary policy will not be an effective instrument and QE in particular is a very long bow to draw if your objective is to stimulate economic activity.
The following graph is taken from the BOE BankStats database and shows monthly UK bank reserves since May 2006. You can see what QE has been doing (along with the expansionary fiscal policy).
Does quantitative easing work? The mainstream belief is based on the erroneous belief that the banks need reserves before they can lend and that quantititative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves.
This is the text-book conception of the world and parades as the money multiplier theory. It is taught – to their disadvantage – to all undergraduate students in economics. It is an exercise in deceptive brainwashing and those who teach it should be brought to bear.
The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
But bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves. The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.
All that the BOE is doing is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the BOE). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.
In terms of changing portfolio compositions, QE increases central bank demand for “long maturity” assets held in the private sector which reduces interest rates at the longer end of the yield curve. These are traditionally thought of as the investment rates.
This might (but probably will not) increase aggregate demand given the cost of investment funds is likely to drop. But on the other hand, the lower rates reduce the interest-income of savers who will reduce consumption (demand) accordingly. How these opposing effects balance out is unclear. Clearly, the BOE research department has no idea of how the effects interact.
Overall, this uncertainty points to the problems involved in using monetary policy to stimulate (or contract) the economy. It is a blunt policy instrument with ambiguous impacts.
Today’s (November 6, 2009) Guardian Editorial recognises that the policy is “not working”:
… Mervyn King and his colleagues yesterday rightly decided that the quantitative easing would carry on for another three months – but they clearly plan to end this experiment in British monetary policy soon. And the outlook for the economy will get even bleaker.
True, the Bank’s policy has not worked as well as hoped. When he launched QE back in March, Mr King set himself the target of raising the amount of money being circulated outside the banking sector – the point being that he wanted the programme to encourage financial institutions to lend more to businesses and consumers, who would in turn invest and spend more. Yet eight months and £175bn has done nothing to lift that all-important measure – as the Bank now admits …
Mr King is not the only one who plans to withdraw his medicine. So does Alistair Darling, who, come the end of this year, will take back his budget giveaways. If George Osborne moves into No 11 next spring, he has made it clear that he will cut spending sharply and rely on the Bank of England to do the heavy lifting through rate cuts. This is daft. If monetary policy is not having the desired effect and the economy is having a near-death experience next year then the government will have to spend more. Otherwise, the spectre of the great depression is likely to return.
That is it in a nutshell – monetary policy has failed because it was never likely to succeed. The Conservatives are unfit to govern the old dart and fiscal policy has so far not been expansionary enough to fill the spending gap.
The reality is the UK Government has to arrest its tendencies to go along with the deficit hysteria lobby. It has to announce a major stimulus package which will not only directly employ those without work (particularly the youth) but also “finance” the saving desires of the private sector which has to reduce its excessive debt levels. As long as the private sector is trying to restore its precarious balance sheets aggregate demand will falter.
Further, as long as they are trying to save – their will be scant borrowing requests to the banking system. The massive reserves the banks hold are totally irrelevant to their capacity to lend. What they lack are credit worthy customers coming through their front doors seeking loans. That will not happen until there is a resumption of economic growth and that will not happen while private spending is in reverse.
The UK Government should be showing leadership here and expanding their fiscal position. The worst legacy they can leave the future generations is to force them as a consequence of their failure to stimulate income growth now to remain unemployed for the years to come. That is the very possibility that presents itself in the UK at present given that nearly 30 per cent of 16-24 year olds who want to work are jobless.
How did England ever win the Ashes? I suppose they will say that the PM is Scottish.
Using the disadvantaged to hedge …
In a recent blog – When a country is wrecked by neo-liberalism – I outlined a desirable policy initiative to help home-owners who were facing eviction from their homes because they could no longer service their debts. I suggested the following process which would be within the capacity of a modern monetary government to implement and fund:
- The government should not interfere with repossession processes. A private contract is a private contract.
- But the government should consult with the defaulting private owner to ascertain if they want to keep their house.
- If they do want to keep their homes, the government should purchase the house from the bank that is foreclosing at the fire-sale price.
- The government should then rent the house back to the former owner for some period – say 5 years.
- At the end of this period the former owner would be offered first right of refusal to purchase the house at the current market price.
- The government would also offer the former owner guaranteed employment in a Job Guarantee, to ensure they are able to pay the rent and reconstruct their personal finances.
- This option does not involve any subsidy operating (market rentals paid, repurchase at prevailing market price); no interference into private contracts, and people stay in their homes.
- There is no moral hazard components within the proposal.
Today, I read that Fannie Mae Announces Deed for Lease Program, which effectively means they wil rent to owners who are facing foreclosure.
Under the scheme:
… qualifying homeowners facing foreclosure will be able to remain in their homes by signing a lease in connection with the voluntary transfer of the property deed back to the lender.
Borrowers or tenants interested in a lease must be able to document that the new market rental rate is no more than 31 per cent of their gross income which in most cases will be below their mortgage payments. The leases wil be for 12 months with some month-to-month extensions.
The question that is left hanging is why not make the plan more comprehensive along the lines I outline above?
Further, under “Deed for Lease” program the person has to “demonstrate they can’t afford their current mortgage, but can pay the rent.”
If the US Government supplemented the plan with a Job Guarantee then the ability to pay the rent would be guaranteed. Joblessness and inability to maintain adequate standards of housing usually go together. That is one of the advantages of an employment guarantee approach – the person does not become poor when they lose their job and encounter all the acommpanying costs.
Of-course, you have to question the motive of the Fannie Mae in this instance. The motivation of my scheme is clear and firmly based grounded in the possibilities that a fiat monetary system provides – that is, the scheme is designed to advance public purpose (provide as much chance to the person to keep their house as possible) without compromising the execution of legal contracts between private agents.
But according to the Fannie Mae spokesperson:
This new program helps eliminate some of the uncertainty of foreclosure, keeps families and tenants in their homes during a transitional period, and helps to stabilize neighborhoods and communities.
The same spokesperson was quoted in the Press today as saying:
If you keep more people in their homes, it’s better for the community. It’s better for the financial institutions that own those homes … Hopefully, less foreclosure product on the market will help stabilise those communities.
So you get the feeling that stabilising the community is about stabilising housing values and the 12 month (then month-to-month) lease arrangements ensures that local property markets are not flooded with new stock arising from the defaults. Further, it is highly likely that the same property markets will have picked up over the course of the lease.
So Fannie Mae is attempting to increase the potential value of its stock and push out the former owners onto a rising rental market – with a bad debt against their names.
Further, the occupancy in the meantime militates against urban blight and vandalism which would further increase the value of the housing when it was released onto the market.
In the same breath (released yesterday), Fannie Mae put out its Third Quarter financial results
On page 1 you will read the following:
The loss resulted in a net worth deficit of $15.0 billion as of September 30, 2009, taking into account unrealized gains on available-for-sale securities during the third quarter. As a result, on November 4, 2009, the Acting Director of the Federal Housing Finance Agency (FHFA) submitted a request for $15.0 billion from Treasury on the company’s behalf. FHFA has requested that Treasury provide the funds on or prior to December 31, 2009.
In other words, they are wanting the US Federal Treasury to net spend an additional $US15 billion. This is in addition to the $US10.7 billion that was provided to them on September 30, 2009. They also expect further Treasury injections in the future. The total public bailout to Fannie Mae is now standing at around $US61 billion.
So why isn’t the US Treasury insisting on a better deal for the disadvantaged homeowner than Fannie Mae appears to be providing them? Why use the defaulting homeowner as a unpaid “caretaker” to safeguard Fannie’s assets until it is profitable to sell the housing?
And before they even talk about defaults, the US Treasury should just introduce a Job Guarantee and boost the minimum wage to a realistic living baseline. Then allow the homeowners to renegotiate all their financial commitments at the new lower interest rates and see whether the combination of those policy changes allows them to keep servicing their loans.
If so, then the so-called toxic debt becomes “good” debt again and the problem is identified as a lack of aggregate demand leading to a lack of jobs. If the person still cannot pay their mortgage commitments under the revised conditions (JG and lower rates) then my housing emergency plan should be invoked. At some time in the future, I would expect all the “renters” to once again be in a position to re-purchase their houses back at the going price.
A much better outcome for the economy and the people. Fannie’s plan (and Freddie Mac’s similar plan announced earlier in the year) is a cheapskate way to improve their own asset values and the US Treasury should get tough with them.
New Red Cross strategy – punch the victims senseless …
The delusional world of the IMF is never far below the surface. In this extract Debating the IMF with Students the IMF head Dominique Strauss-Kahn was in Turkey in early October and gave an address to some students on the “role of the IMF in the current crisis”.
In his address to the students he:
… likened the IMF to an “economic Red Cross” because its goal is to help solve a country’s economic problems while avoiding social unrest and war … he pointed out that countries only need IMF resources when they are “sick” – when they face serious balance of payments problems requiring policy adjustment. If you go to the doctor with a liver problem, he mused, the doctor will treat you, yes, but will also insist that you stop drinking. So policy conditions are necessary …
But under questioning, he admitted:
… the medicine had sometimes been too bitter in the past. The IMF had developed a “harsh image” – not paying enough attention to local circumstances, political realities, or social consequences. It was seen as more of a policeman than a doctor.
Tomorrow … Saturday Quiz
Regular reader Marshall A. tells me he has scored 100 per cent 5 weeks in a row now. I told him I would fix that. So a particularly tricky quiz is coming tomorrow … only the true MMT crew will get 100 per cent. (Cultural note: Americans – I am joking here!).