Must-read: Adair Turner: “Are Central Banks Really Out of Ammunition?”

Must-Read: Adair Turner: Are Central Banks Really Out of Ammunition?: “The global economy faces a chronic problem of deficient nominal demand…

…But the debate about which policies could boost demand remains inadequate, evasive, and confused. In Shanghai, the G-20 foreign ministers committed to use all available tools – structural, monetary, and fiscal – to boost growth rates and prevent deflation. But many of the key players are keener to point out what they can’t do than what they can….

Central banks frequently stress the limits of their powers, and bemoan lack of government progress toward ‘structural reform’…. But while some [SR measures] might increase potential growth over the long term, almost none can make any difference in growth or inflation rates over the next 1-3 years…. Vague references to ‘structural reform’ should ideally be banned, with everyone forced to specify which particular reforms they are talking about and the timetable for any benefits that are achieved…. Central bankers are right to stress the limits of what monetary policy alone can achieve…. Negative interest rates, and… yet more quantitative easing… can make little difference to real economic consumption and investment. Negative interest rates… [may have the] the actual and perverse consequence… [of] higher lending rates….

Nominal demand will rise only if governments deploy fiscal policy to reduce taxes or increase public expenditure – thereby, in Milton Friedman’s phrase, putting new demand directly ‘into the income stream.’ But the world is full of governments that feel unable to do this. Japan’s finance ministry is convinced that it must reduce its large fiscal deficit…. Eurozone rules mean that many member countries are committed to reducing their deficits. British Chancellor of the Exchequer George Osborne is also determined to reduce, not increase, his country’s deficit. The standard official mantra has therefore become that countries that still have ‘fiscal space’ should use it. But there are no grounds for believing the most obvious candidates – such as Germany – will actually do anything….

These impasses have fueled growing fear that we are ‘out of ammunition’…. But if our problem is inadequate nominal demand, there is one policy that will always work. If governments run larger fiscal deficits and finance this not with interest-bearing debt but with central-bank money…. The option of so-called ‘helicopter money’ is therefore increasingly discussed. But the debate about it is riddled with confusions.

It is often claimed that monetizing fiscal deficits would commit central banks to keeping interest rates low forever, an approach that is bound to produce excessive inflation. It is simultaneously argued (sometimes even by the same people) that monetary financing would not stimulate demand because people will fear a future ‘inflation tax.’
Both assertions cannot be true; in reality, neither is. Very small money-financed deficits would produce only a minimal impact on nominal demand: very large ones would produce harmfully high inflation. Somewhere in the middle there is an optimal policy…. The one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible. If political irresponsibility is inevitable, we really are out of ammunition that we can use without blowing ourselves up. But if, as I believe, the discipline problem can be solved, we need to start formulating the right rules and distribution of responsibilities…


Brad DeLong


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