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CENTRAL BANKING AND
MONETARY POLICY AFTER THE CRISIS
Adair Turner
Senior Fellow, Institute for New Economic Thinking
OMFIF City Lecture
10 December 2014
www.ineteconomics.org
300 Park Avenue South | New York, NY 10010
22 Park Street | London W1k 2JB
Recent central bank actions
Federal
Reserve
Purchase of MBS
Bank of
England
FLS with “incentives for lending
skewed towards SMEs”
ECB
Targeted LTRO: for non-mortgage bank
lending
PBOC
Targeted reserve requirement
reductions for lending to agriculture and
small business
Bank of
Korea
Stimulus package: finance for SMEs
1
Private domestic credit as a % of GDP:
Advanced economies 1950 – 2011
Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013
2
Debt contracts:
The finance theory perspective
Non-state contingent contracts overcome “costly state
verification” advantages over equity contracts in
business finance
Essential to mobilisation of capital
Empirical evidence of benefits of financial deepening,
i.e. bank credit ÷ GDP
3
Pre-crisis orthodoxy: monetary policy
We assumed that we
could ignore much of
the details of the
financial system
Mervyn King
Twenty Years of Inflation Targeting,
The Stamp Memorial Lecture, 2012)
Olivier Blanchard
Chief Economist of the IMF, October 2012
The dominant new Keynesian
model of monetary economics
lacks an account of financial
intermediation, so that money,
credit and banks play no
meaningful role
4
Wicksell’s logic: I
Credit extended to entrepreneurs/businesses to fund capital
investment
Marginal productivity of capital = Natural rate of
interest
If Policy/Market rate < Natural
rate
Mal-investment and
inflation
If Policy/Market rate = Natural
rate
Optimal investment
and price stability
5
Wicksell’s logic: II
Natural rate is unobservable
But if Policy rate varied to ensure price stability
Then Policy/Market rate ͠ Natural rate
Inflation targeting objective
Credit creation and leverage optimal if price stability achieved
6
Three conceptually distinct functions of
lending
Finance of new capital • Non-real estate
investment • Commercial real estate
• Residential real estate
• Human capital
Finance of increased • Enabling inter-temporal shift of
consumption within life time income
consumption
Finance of purchase of • Real estate
existing assets • Collectibles
• Existing business assets – e.g. Leveraged
Buy Outs
7
Categories of bank lending: UK, 2009
£bn
Other corporate
232
Primarily productive investment
243
Some productive investment and some
leveraged asset play
Residential mortgage
(including securitizations
and loan transfers)
1235
Mainly purchase of existing assets
But also achieves life-cycle
consumption smoothing
Unsecured personal
227
Commercial real estate
Pure life-cycle consumption smoothing
8
Share of real estate lending in total
bank lending
70%
0.6
60%
0.5
50%
0.4
40%
0.3
30%
0.2
20%
0.1
10%
2010
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
1890
0
1880
Ratio of real estate lending to total lending
0.7
Source: The Great Mortgaging, Jordá, Schularick and Taylor, 2014
9
“With very few exceptions, the banks’ primary
business consisted of non- mortgage lending
to companies in 1928 and 1970. By 2007 banks
in most countries had turned primarily into
real estate lenders.
The intermediation of
household savings for productive investment in
the business sector – the standard textbook
role of the financial sector – constitutes only a
minor share of the business of banking today.”
(Oscar Jordá, Moritz Schularick and Alan Taylor,
The Great Mortgaging, 2014)
10
Credit and asset price cycles: upswing
Increased
credit extended
Increased lender
supply of credit
Increased
borrower
demand for
credit
Increased
asset prices
Expectation of
future asset price
increases
Favourable
assessments of
credit risk
Low credit losses: high
bank profits
• Confidence reinforced
• Increased capital base
11
Credit and asset price cycles: downswing
Less credit
extended
Restricted lender
supply of credit
Reduced
borrower
demand for
credit
Falling asset
prices
Expectation of
future asset price
falls
Cautious
assessments of
credit risk
High credit losses: low
bank profits
• Confidence dented
• Reduced capital base
12
Credit extension and house prices
Household debt as a % of GDP 2000 – 2007
House prices 2000 – 2007
250
120
100
80
150
% GDP
Index: 2000 = 100
200
60
100
40
50
20
0
0
Q1 2000
Spain
Q1 2001
Q1 2002
US
Q1 2003
Q1 2004
Q1 2005
Q1 2006
UK
Source: Ministry of Housing (Spain), S&P (US), DCLG
Q1 2007
Ireland
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
US
UK
Spain
Ireland
Source: BEA; ONS; ECB
13
Real estate a dominant risk in advanced
economies – even without leverage
Real economy debt overhang the
crucial driver of post crisis recession –
not just impaired financial system
Excessive credit growth may never
result in excessive inflation
14
Capital in Britain 1700 – 2010
800%
Net foreign assets
Other domestic capital
700%
Housing
Agricultural land
500%
400%
300%
200%
100%
2010
1990
1970
1950
1920
1910
1880
1850
1810
1750
0%
1700
% national income
600%
Source: Capital in the Twenty First Century, T. Piketty (2013)
15
Desirable urban land: a market without
equilibrium?
Highly income
elastic demand
Capital gains
motivation
Indeterminate
price – is there
an
equilibrium?
Inelastic
supply of
locationally
specific land
Expectations prices
expectations
Potentially infinite
supply of credit
and private money
16
Sectoral financial surpluses/deficits as
% of GDP: Japan 1990 – 2012
10
5
0
%
-5
-10
-15
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
PNFCs
Government
Source: IMF, Bank of Japan Flow of Funds Accounts
17
Japanese government and corporate debt:
1990 – 2010
250
% GDP
200
150
100
50
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008 20010
0
Bank lending to non-financial corporates
General Government debt
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
18
Shifting leverage:
Private and public debt-to-GDP
19
Global debt excluding financials
Developed Markets
Emerging Markets
World
280
260
% of GDP
240
220
200
180
160
140
120
100
01
02
03
04
05
06
07
08
09
10
11
12
13
Source: Geneva Report No 16 Deleveraging, What Deleveraging? ICMB / CEPR September 2014
20
100
140
90
120
80
100
2013
2012
2011
2010
2009
2008
2007
180
2006
130
2005
200
2004
140
2003
% of GDP
150
2002
1991-Q1
1992-Q2
1993-Q3
1994-Q4
1996-Q1
1997-Q2
1998-Q3
1999-Q4
2001-Q1
2002-Q2
2003-Q3
2004-Q4
2006-Q1
2007-Q2
2008-Q3
2009-Q4
Total German private sector
leverage: 1991 - 2010
China: total social
finance to GDP
% of GDP
220
120
110
160
21
Categories of credit creation and
nominal demand
Finance of investment
Finance of consumption
Finance of existing
asset purchase
Stimulates nominal demand
Stimulates nominal demand
but
required just to offset impact of inequality ?
• No direct stimulus to nominal demand
• Could just increase credit, money balances
and asset pricing
• May stimulate demand via wealth effects
and Tobin’s Q effects
• But not certainly proportional to credit
created
22
UK Credit, money and demand
2000 – 2007
% change
105%
House prices
97%
Mortgage credit
79%
Houshehold deposits
Nominal GDP
44%
23
Bank lending to real estate sector and
prices: Japan 1981 – 1999
YoY%
60%
50%
40%
Commercial Land Price in
the Six Major Cities (L)
30%
40%
25%
30%
20%
10%
35%
20%
Bank Lending to the Real
Estate Sector (R)
0%
15%
10%
5%
-10%
0%
-20%
-5%
-30%
-10%
Source: Japan Real Estate Institute; Bank of Japan; Profit Research Center Ltd; calculations by Prof.
Richard Werner, Southampton University (see Princes of the Yen, Richard Werner, 2003)
24
Credit creation for GDP transactions and
nominal GDP in Japan, 1983 – 1999
YoY %
YoY %
12
12
10
10
8
8
6
6
Nominal GDP
4
4
2
2
0
0
-2
-2
-4
Cr (L)
83
85
87
89
91
93
95
97
-4
99
Source: Princes of the Yen, Richard Werner, 2003
25
Quantity theory of disaggregated credit*
NOT
But:
∆
M = ∆P. ∆Y
∆CR
= ∆PR
Velocity of circulation stable
… where CR = credit to finance
real estate purchase+
PR = price of real estate
And:
∆CNR
= ∆P. ∆Y
… CR = credit to finance GDP
transactions
P = prices of current goods and
services
So that:
∆M
= ∆CR + ∆CNR > ∆P. ∆Y
Velocity of circulation falls
* See Richard Werner, New Paradigm in Macroeconomics
+ Or more generally to finance existing assets
Explaining instability and secular stagnation
| 26
UK (M2)
Japan (M2)
Japan (M4)
UK (M4)
Source: BoE, BoJ, Datastream
27
Q4 2010
Q2 2009
Q4 2007
Q2 2006
Q4 2004
Q2 2003
Q4 2001
Q2 2000
Q4 1998
Q2 1997
Q4 1995
Q2 1994
Q4 1992
0.0
Q2 1991
0.5
Q4 1989
1.0
Q2 1988
Velocity of Money
(Nominal GDP/M2)
Q4 1986
1.5
Q2 1985
2.0
Q4 1983
2.5
Q2 1982
3.0
Q4 1980
Q4 2010
Q2 2009
Q4 2007
Q2 2006
Q4 2004
Q2 2003
Q4 2001
Q2 2000
Q4 1998
Q2 1997
Q4 1995
Q2 1994
Q4 1992
Q2 1991
Q4 1989
Q2 1988
Q4 1986
Q2 1985
Q4 1983
Q2 1982
Q4 1980
Velocity of money circulation
Velocity of Money
(Nominal GDP/M4)
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
Monetary aggregates matter
But not because excessive Money is a
forward indicator of inflation
But because excessive Credit is a forward
indicator of crisis, debt overhang, post crisis
depression and deflation
28
Not one objective, one instrument
Low and stable inflation
insufficient
Interest rate tool
insufficient
Credit and asset price cycle
and rising leverage can
produce macroeconomic
instability while never
producing excess inflation
• Interest rate elasticity of
demand for credit varies
by category
• Contrary to Wicksell,
there is no one natural
rate
29
Interest rates as primary policy tool?
Advantage
Arbitrage
helps
policy
Gets into
all the
cracks
Disadvantage
Heterogeneity and
instability of expected
returns and elasticity of
response
30
Other policy objectives and tools
Objectives
Tools
• Constrain both pace of growth
of credit
• Much higher bank capital
requirements
• Much higher counter-cyclical
capital requirements
• … and the level of private
sector leverage
• Increase capital risk weights for
real estate lending above IRB
levels
• Loan to income constraints on
borrowers
• Banks with dedicated focus on
non real estate
• Offset bias in system toward
real state lending
31
Recent central bank actions
Federal Reserve
Purchase of MBS
Bank of England
FLS with “incentives for lending
skewed towards SMEs”
ECB
Targeted LTRO: for non-mortgage bank
lending
PBOC
Targeted reserve requirement
reductions for lending to agriculture and
small business
Bank of
Korea
Stimulus package: finance for SMEs
32