Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 5 August 2016

Negative rates, helicopter money and the Bank of England

Yesterday Mark Carney said he was against negative interest rates and helicopter money, but in reality he implemented a way of doing a version of both. Let me explain.

When negative interest rates are discussed, we normally think about savers, and the fact that they could avoid being charged to deposit money in a bank by hoarding cash. But borrowers would have no problem with negative rates: borrow £1000, and just pay back £990. The bank they borrowed from would have, unless there were negative rates on savings or they were getting a subsidy to lend.

Helicopter money is normally thought of as the central bank sending a cheque to every citizen. But the key point for economists is not the way the money is distributed, but the fact that it is created by the central bank and given away in return for nothing. (QE involves creating money to buy assets.) Who the money goes to is of course important, but it is not really the defining characteristic of the measure.

We normally think about monetary policy as changing the interest rate. If rates are cut, that benefits borrowers but is bad for savers. But suppose the central bank gave money to private banks, on condition that this money was passed on in the form of lower rates to borrowers. If it did this, but did not change the interest rate, that would be helping borrowers but not hitting savers. The Bank introduced such a scheme yesterday, called the Term Funding Scheme (TFS). What is more, this subsidy for borrowers is financed by creating money. Eric Lonergan argues that the ECB is doing something similar, and if there is any insight in this post I owe it to him (but if there isn’t it is my fault not his!).

So if you think the Bank has ruled out negative rates, you are half wrong. In principle the Bank can expand TFS to make borrowing as cheap as it likes, which could even mean negative interest rates for borrowers. If you think the Bank has ruled out helicopter money, you are half wrong. It is creating money to give away with nothing in return, but just giving the money to one particular group: borrowers.

Now if you are a saver you might say why cannot I rather than borrowers benefit from this money give away. But the Bank could argue that without TFS it would have to reduce the interest rate by even more than it has, which would make savers a lot worse off. So compared to that outcome, you are better off. Whether you find that convincing when you can always hold cash depends on the cost of holding cash.

So why did Mark Carney say that helicopter money was a flight of fancy, when he was in fact doing something quite similar? It is a good question to ask him. I suspect the real answer is that TFS looks like the kind of thing a central bank does, but giving money to every citizen looks like fiscal policy. But what it does mean is that in terms of the basic macroeconomics, the Bank of England is now doing helicopter money. But if you are neither a borrower or a saver and feel aggrieved you are not getting anything, you know who to complain to.

24 comments:

  1. “If you think the Bank has ruled out helicopter money, you are half wrong. It is creating money to give away with nothing in return, but just giving the money to one particular group: borrowers.”

    Why the asymmetry?

    You may as well say that IOR under positive rates is helicopter money. A negative rate earned by borrowers is no more “giving away money” than a positive rate earned by lenders.

    And for that matter, no more than compensation earned by the bank staff. That’s just labor versus capital.

    This is just cherry picking stuff from the income statement and reverse engineering that into a so-called HM characteristic.

    HM has to be defined by the underlying fiscal purpose, with monetary financing as the accompanying characteristic.

    Negative rates just flip the interest rate relationship between borrower and lender. There’s nothing inherently helicopterish about either side of that equation. The basic business of central banking is about financial intermediation. It's reasonable and not unexpected that Carney refers to HM proper as a flight of fancy.

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  2. Well I certainly wish to complain to Mark Carney. My complaint is this.

    Given inadequate demand, whence your assumption that the best way of increasing it is more lending and hence more debt? The basic purpose of the economy is to produce what consumers want (both consumer goods and the publically supplied goods that consumers vote for at election time). So given inadequate demand, the obvious solution is fiscal stimulus, with interest rates being left to find their own level.

    So why, Mr Carney, are you not badgering government to do more fiscal stimulus? That would not constitute moving into POLITICAL territory: it’s a strictly ECONOMIC point, and one of your jobs is to advise politicians on economics.

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    1. «Given inadequate demand, [ ... ] more lending and hence more debt?»

      But the new phase of the "Help to Borrow" policy is actually not quite *just* "Help to Borrow", even if that's the spin.

      What our blogger is describing is actually a policy to widen the "spread" for banks.

      That is if the banks were borrowing at 0.5% and lending at 3.5% to mortgage speculators, with a 3% spread, now the BoE is giving the banks an extra spread 1% or 2% or whatever, doubling or tripling their net profitability. The banks can use that extra spread to pay their managers more, or build up capital, or even to bring down the interest rate on mortgages and thus give more cheaper borrowing to asset speculators, generating an even bigger asset price boom.

      But giving the banks extra spread is even "better" than that: the banks can currently borrow at 0.5% (actually now 0.25%) to buy long term government bonds that pay more than that, e.g. 1.5% for 30 year gilts, for an effortless risk-free (because the government will bail them out) spread of around 1%. But if the BoE gifts them 1% of extra spread, uncork the champagne!

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    2. Ralph, I don't think the move was mainly designed to boost lending and debt. In reality a 25bp rate cut will have only a marginal impact on credit demand. (There is possibly a boost to credit demand via increased confidence from those who think the Bank is acting decisively, although I also have sympathy for those claiming it shows desperation and may thereby lower confidence and credit demand.) Instead the impact will be felt mainly through lower mortgage repayments for those on tracker-type mortgages. TFS is a clever way of making sure that happens without affecting savers, as Simon indicates.

      I'm also happy the Bank has started corporate QE, with a focus on investment grade non-financials that make a significant contribution to the UK economy - I await the inevitable controversy.

      For what it's worth, I think the Bank did the right thing but it is at the limits of what it can do. £20 or so extra a month on average will not reignite the economy. We get bigger moves in the tax codes from year to year without batting an eyelid.

      It's down to Mr Hammond and the Brexit negotiators now.

      S

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  3. The Bank of England is doing a fiscal policy because it carry a unresolved liability for banknotes in circulation. Here: Seigniorage: The Honest Government's Guide to the Accounting of the Revenue from Money Creation http://leconomistamascherato.blogspot.it/2016/07/banknotes-and-currency-are-liability-of.html

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    1. That article lays great stress on WHO OWNS a central bank. Ownership is actually irrelevant: the important point is the RULES a central bank has to obey. E.g. most central banks (private or publicly owned) hand over all profits to their treasury. So what does "private ownership" amount to?

      The Bank of England is actually owned by UK Treasury solicitor. Lucky old him or her, is all I can say. Don't see where that gets the Treasury Solicitor.

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  4. At what point does the world accept that the credit-bubble years before the crash did not represent any real economic growth, and it was a distortion that has projected its malign effects into the subsequent decade?

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    1. «The Bank introduced such a scheme yesterday, called the Term Funding Scheme (TFS). What is more, this subsidy for borrowers is financed by creating money. [ .... ] can expand TFS to make borrowing as cheap as it likes, which could even mean negative interest rates for borrowers. [ ... ] is creating money to give away with nothing in return, but just giving the money to one particular group: borrowers.»

      So the BoE is subsidizing leveraged asset speculation on margin with their "Help to Borrow" policy. Who could have imagined... :-)

      «the credit-bubble years before the crash did not represent any real economic growth, and it was a distortion»

      It generated a lot of real economic growth for leveraged asset speculators on margin, for example landlords in London and the south east, and they regard it as a splendid reward for being "wealth creators", not a distortion.

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    2. Gyrations in the amount of lending and debt are certainly helpful, or if you like, they are "malign". As to whether the bubble brought genuine growth, I'd say "yes", at least in this sense. Credit growth boosts demand (as Steven Keen points out), and assuming there is room for that extra demand, then the result will be increased growth.

      As to whether that was a "distortion", that depends on what the genuine free market rate of interest is, which is not an question to which there is an easy answer. But I go along with Milton Friedman and Warren Mosler who claim governments should borrow nothing. In that sense, the "genuine" free market rate is zero.

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    3. I think you are being overly optimistic about the time scale; in the 34 years that I have lived in the City of London I would be hard pressed to find any year when we were not reaping what we had sown. My personal experience started with the Sovereign Debt fiasco and moved on to the Savings and Loans debacle; as far as I am aware the world record set then for a loss on one single trade of a quarter of a billion $US still stands. After that things went downhill...

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    4. «Credit growth boosts demand (as Steven Keen points out), and assuming there is room for that extra demand, then the result will be increased growth»

      But demand and growth where? Because credit growth can boost demand for imports, for example. When the right-wing parties in Greece 2004-2012 borrowed up to 15-20% of GDP per year and distributed that to their constituents, imports also got up to 15-20% of GDP, and thanks to the trade activity based on imports, GDP also went up by 20%. That however seemed to me a "distortion".

      You also surely know that in the medium-long term it matters what that «extra demand» is for; if for productive investment then it generates value, if for asset speculation it just has a redistributive impact, for consumption it just has a time shifting effect.

      Plus «credit growth» does not come free; while interest rates can be low, and rolling over ever greater levels of debt may be easy with the "cooperation" of the central bank, if there is a difficult moment the amount (and profile) of debt outstanding does become an issue, as M Pettis has amply shown.

      But all of the above is irrelevant in the UK in practice; UK politicians know very well that to win elections they need a credit fueled "Barber" consumption boom, or a credit fueled "Lawson" house price boom.

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  5. For the sake of this post please assume there is no taxation!
    For the economy to get into the mess it’s in (& we wouldn’t even be contemplating helicopter money if it wasn’t) then the only cause of this mess can be the deals done in the market! If the price is too high then it drains money from those that are being over priced,if the price is too low it stops re-investment and therefore being able to bring your product to market!
    Whilst this simplistic view isn’t particularly realistic of the world in effect all trades do break down to its simplest form(otherwise we wouldn’t be experience what were going through)it does open the window into the problems we face,it is very obvious from the data that bad deals have been done and one side of the equation is and has been suffering and now that suffering is impacting on the side that did rather well from the bad deals!
    QE is to buy assets but only those that benefited from the bad deals can afford them and it therefore creates asset bubbles that only makes matters worse.(Wrong Taxation can make this worse)
    Helicopter money going to everyone will not help,since the asset bubbles are priced out of reach since the helicopter money also goes to those that gained! The asset will rise proportionately to the part of sum that is administered)
    Only by targeting those that lost out in the bad deals can helicopter money reassert that those deals are made good! (Or brought back to anything like equilibrium or there abouts + or - some small differences).between the amount of helicopter money used and the true effect of the bad deals (good taxation would normally help in this matter) (bad taxation hinder)
    If there isn’t any tax has i have asked you to believe then prices would have to drop to the level that are affordable otherwise there will be no reason to bring products to market because no one CAN buy!,We see all sort of chocolate bars shrinking to make them affordable but this destroys the value in the deal even more,because of the knock on effect using lower and lower amounts (whilst actually increasing the amount of money created) the market destroys itself through bad deal after bad deal and breaking the window of opportunity,taking this line explains why we're in a mess why we can’t escape the mess and even if we target helicopter money to the losers we will soon be back in this mess!
    Obviously knowing which are good deals isn’t simple,but knowing who the winners and losers is! (& taxation is the best way to solve the problem of bad deals)

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  6. When in 2009 the Labour party started £ 375 Billion of quantitive easing to save the world economy from an unanticipated subprime crisis, the Conservatives were quick to blame the Labour party of financial miss-management. But when in 2016 the conservatives inject £ 70 Billion of quantitive easing (19% of the above figure) to cover up their wrecking of the economy... It almost goes unnoticed.

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  7. TFS is definitely a subsidy to banks, but it's more subtle than giving money away. If it works perfectly and there are no defaults, the BoE will break even (not counting administrative costs). In other words, the BoE is taking a risk and getting nothing in return. This can be obfuscated as not costing the treasury, unlike an outright gift.

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    1. «TFS is definitely a subsidy to banks, but it's more subtle than giving money away. If it works perfectly and there are no defaults, the BoE will break even»

      Well, if our blogger says «this subsidy for borrowers is financed by creating money» then obviously it is both «giving money away» and «break even» as the "cost" of the gift to the banks is covered by «creating money» seignorage, not by a decrease in the BoE's existing "capital".

      BTW in an interview E Lonergan said:

      «There are now two important policy rates in the UK: base rate and the interest rate at which the Bank of England lends under its TFS programme. This is already a major break with history, when the Bank only lent directly to banks at penal interest rates. In future, there is no reason why the BoE cannot continue to cut the TFS rate and leave Base rates unchanged. In other words, there is no lower bound to the interest rate on TFS.»

      There is a more interesting aspect to this: currently both rates are currently the same. But the discount rate is overnight, while presumably the TFS rate is long term, because obviously it is meant to widen the spread that banks enjoy on mortgages (margin speculation on land) and stock collateralized loans (margin speculation on shares). If that's the case, a *long term* (or even medium term) rate of 0.25% to fund land and share speculation is a big thing, much bigger than a discount rate of 0.25%.

      TFS is the complement of the Special Interest Rate Bonds for Tory Pensioners, it is Special Interest Rate Loans to Tory Bankers and Speculators. The goal of both is to widen spreads between active and passive rates, the former by paying higher passive rates to Tory Pensioners without raising active rates, the latter by charging Tory Bankers and Speculators lower active rates without cutting passive rates.

      In essence it is very similar to charging different exchange rates to different people depending on how clsoe "friends" they are, common in banana republics and kingdoms.

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    2. «a *long term* (or even medium term) rate of 0.25% to fund land and share speculation is a big thing, much bigger than a discount rate of 0.25%»

      It is even bigger because in effect it is unsecured as per your «If it works perfectly and there are no defaults».

      «TFS is the complement of the Special Interest Rate Bonds for Tory Pensioners, it is Special Interest Rate Loans to Tory Bankers and Speculators.»

      Put another way, TFS is the apotheosis of "private keynesianism" well named by C Crouch.

      Or even worse, compare with J McDonnell's QE for People:

      * TFS can well be used to subsidize buying imports, or Bermuda hedge funds shorting Taiwanese shares or USA companies building factories in China, not just pumping up margin speculation on UK property and shares; money is fungible.

      * QE for People would be used to build up UK productive capital while creating jobs (mostly) in the UK. Too bad that would be "inflationary", because the definition of "inflation" is more jobs and better wages for the "moochers and looters" in the bottomost 80%.

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    3. «TFS is the complement of the Special Interest Rate Bonds for Tory Pensioners, it is Special Interest Rate Loans to Tory Bankers and Speculators.»

      When "Special Interest Rate Bonds for Tory Pensioners" were introduced D Cameron argued that they were a small token of gratitude by the nation to the tory pensioners who had fought in WW2 70 years ago. I guess that M Carney has decided that the middle aged tory bankers and speculators who also fought in WW2 70 years ago deserved their small token of gratitude too :-).

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  8. But would that not bring down the banks' profits as "old" borrowers would want to renegotiate to the lower rates as soon as they possibly could. Switch banks if need be?

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  9. What's so crazy about all of this are the following:

    a) Loans create deposits.

    b) Building bank reserves will not expand credit.

    c) Building bank reserves is not inflationary.


    The Bank Of England themselves done a report on this

    http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf


    Yet, Carney has just declared the exact opposite of what was in their own report.

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  10. «Labour party started £ 375 Billion of quantitive easing to save the world economy from an unanticipated subprime crisis,»

    That "unanticipated" and "world economy" is a bit rich here: the UK specific version of the financial crisis was largely homemade, as New Labour, to create electorally advantageous consumption and property price booms, pulled out all stops in financial speculation, and pushed up lending leverage, for 15 years. Lots of people thought and said that would make for a very big build-up of private debt risk, which would eventually happen. The trigger perhaps came from the USA, but the private debt based financial crisis had been baked in by New Labour, with the enthusiastic complicity of the Conservatives and the Liberals too.

    Note: as SimonWL well argued, New Labour did not create a fiscal crisis as such, with excessive *public* debt, contrary to the laughable propaganda of the Conservatives. But that's quite a different topic, that of "private keynesianism" from C Crouch.

    The Conservatives in government have also «pulled out all stops in financial speculation, and pushed up lending leverage». What voters in the higher 50% of the income distribution want is Barber or Lawson private debt booms, ideally both.

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  11. Ahhhh it just occurred to me: the TFS etc. stimulus package smells a lot like a pre-election giveaway.

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  12. With large amount of monetary stocks, bankers prefer risk free assets to risky assets, because the return of risk free assets is adequate for banks to be profitable. When people take risks? I suppose that when cash flow is negative and survival is endangered. So the problem is not from central bank, but from banks.

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  13. One more thing - property prices will likely rise because of 1) lower mortgage repayments 2) the pound's drop will incentivise many foreigners to invest 3) stable demand and permanent housing shortfall in the UK. House prices will likely increase by 2% by the end of 2016 and further in the future (if you are interested how further, go to https://tranio.com/united-kingdom/analytics/the-bank-of-englands-base-interest-rate-drop-what-to-expect-in-the-real-estate-market_5177/)

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  14. Forgive the nit-picking, but there's a technicality about helicopter money that I would like someone to clarify for me please. If the BofE prints money and gives it away, its liabilities increase with no matching increase in its assets. How is this reconciled with the necessity in double-entry book-keeping for assets and liabilities to be equal?

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