A few days ago Adair Turner, former chair of the Financial Services Authority, made a bold speech in which he made a number of points already made in many of my previous posts about the causes and ways of tackling the global financial crisis. For example, he stated that:
-the global financial crisis was the result of an unsustainable increase in the private sector debt to GDP ratio driven by excessive bank lending, which was mistakenly ignored by mainstream economists and policymakers, who claimed it did not matter. This inflated asset prices bubbles which inevitably burst, causing financial mayhem.
-the subsequent recession is a result of the fact that the private sector are deleveraging, and that government deficits are required to enable this deleveraging. Trying to cut them is therefore seriously misguided and counterproductive.
-deficit spending is healthy when there is a deficiency in demand and should be encouraged as a way of regulating aggregate demand
-efforts to restore growth by increase bank lending are unlikely to succeed and are potentially hazardous as they recreate the problem that cause the financial crisis in the first place.
-banks need to be much more tightly regulated and should have much higher capital and reserve requirements. He makes the important points that all these lessons were learnt following the great depression, but have been forgotten.
Interestingly, he argues that government deficits are financed directly by central banks creating money - also called helicopter money. The reason he advocates this is that deficit spending financed by government borrowing results in a growing government debt. He thinks this is a bad thing because it will have a psychological impact on the private sector. They will worry about the fact that the resulting debts will eventually need to be repaid, and that this will require higher taxes, which will cause people to save now, depressing demand. This is called Ricardian equivalence. A solution to this psychological problem is to explain that government debt just represents net private sector savings, which is a benefit not a burden, and there is no reason why these savings need to be decreased in future. Provided that the government has its own currency and central bank it can set the interest rate on this debt and cannot default on it. In fact it is the safest place for the private sector to keep savings. Government debt serves a useful purpose as a safe asset for banks and investors such as pension funds.
The real difference between deficit spending financed by the central bank and deficit spending accompanied by issuing government debt is that instead of the extra money created by the deficit being kept in non-interest bearing reserve accounts at the central bank it is moved into interest bearing savings accounts at the central bank.
-the global financial crisis was the result of an unsustainable increase in the private sector debt to GDP ratio driven by excessive bank lending, which was mistakenly ignored by mainstream economists and policymakers, who claimed it did not matter. This inflated asset prices bubbles which inevitably burst, causing financial mayhem.
-the subsequent recession is a result of the fact that the private sector are deleveraging, and that government deficits are required to enable this deleveraging. Trying to cut them is therefore seriously misguided and counterproductive.
-deficit spending is healthy when there is a deficiency in demand and should be encouraged as a way of regulating aggregate demand
-efforts to restore growth by increase bank lending are unlikely to succeed and are potentially hazardous as they recreate the problem that cause the financial crisis in the first place.
-banks need to be much more tightly regulated and should have much higher capital and reserve requirements. He makes the important points that all these lessons were learnt following the great depression, but have been forgotten.
Interestingly, he argues that government deficits are financed directly by central banks creating money - also called helicopter money. The reason he advocates this is that deficit spending financed by government borrowing results in a growing government debt. He thinks this is a bad thing because it will have a psychological impact on the private sector. They will worry about the fact that the resulting debts will eventually need to be repaid, and that this will require higher taxes, which will cause people to save now, depressing demand. This is called Ricardian equivalence. A solution to this psychological problem is to explain that government debt just represents net private sector savings, which is a benefit not a burden, and there is no reason why these savings need to be decreased in future. Provided that the government has its own currency and central bank it can set the interest rate on this debt and cannot default on it. In fact it is the safest place for the private sector to keep savings. Government debt serves a useful purpose as a safe asset for banks and investors such as pension funds.
The real difference between deficit spending financed by the central bank and deficit spending accompanied by issuing government debt is that instead of the extra money created by the deficit being kept in non-interest bearing reserve accounts at the central bank it is moved into interest bearing savings accounts at the central bank.
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