Our good friend and die hard British market monetarist Britmouse has a new post on his excellent blog Uneconomical. I think it might just be the coolest idea of the year. Here is Britmouse:
“Will the ECB will stand by and let Spain go under? Spain is a nice country with a fairly large economy. It’d be a… shame, right? So if the ECB won’t do anything, I think the UK should act instead.
David Cameron should immediately instruct the Bank of England to print Sterling, exchange it for Euros, and start buying up Spanish government debt. Spain apparently has about €570bn of debt outstanding, so the Bank could buy, say, all of it.
We all know that the Bank of England balance sheet has no possible effect on the UK economy except when it is used to back changes in Bank Rate. Right? So these actions by the Bank can make no difference to, say, the Sterling/Euro exchange rate, and hence no impact on the demand for domestically produced goods and services in the UK. Right?
Sure, the Bank would take on some credit risk and exchange rate risk. But they can do all this in the Asset Purchase Facility (used for conventional QE), which already has a indemnity from the Treasury against losses.”
Your reaction will probably be that Britmouse is mad. But you are wrong. He is neither mad nor is he wrong. British NGDP is in decline and the Bank of England need to go back to QE as fast as possible and the best way to do this is through the FX market. Print Sterling and buy foreign currency – this is what Lars E. O. Svensson has called the the foolproof way out of a liquidity trap. And while you are at it buy Spanish government debt for the money. That would surely help curb the euro zone crisis and hence reduce the risk of nasty spill-over to the British economy (furthermore it would teach the ECB as badly needed lesson…). And by the way why do the Federal Reserve not do the same thing?
Obviously this discussion would not be necessary if the ECB would take care of it obligation to ensure nominal stability, but unfortunately the ECB has failed and we are now at a risk of a catastrophic outcome and if the ECB continues to refuse to act other central banks sooner or later are likely to step in.
You can think of Britmouse’ suggestion what you want, but think about it and then you will never again say that monetary policy is out of ammunition.
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Update – this is from a reply below. To get it completely clear what I think…
“Nickikt, no I certainly do not support bailing out either bank or countries. I should of course have wrote that. The reason why I wrote that this is a “cool idea” is that is a fantastic illustration of how the monetary transmission mechanism works and that monetary policy is far form impotent.
So if you ask me the question what I would do if I was on the MPC of Bank of England then I would clearly have voted no to Britmouse’s suggestion. I but I 100% share the frustration that it reflects. That is why I wrote the comment in the way I did.
So again, no I am strongly against bail outs and I fear the consequences in terms of moral hazard. However, Spain’s problems – both in terms of public finances and the banking sector primarily reflects ECB’s tight monetary policy rather than banking or public finance failure. Has there been mistake made in terms and public finances and in terms of the banking sector? Clearly yes, but the main cause of the problems is a disfunctional monetary union and monetary policy failure.”
nickikt
/ June 14, 2012Do you support ‘bailing out’ countrys? I mean isn’t it a bit to risky? If spain acctually does default the amount of bounds out would over time creat artefical inflation (overshoot NGDP target) and the central bank would actually be out of weapons, they cant print sterling to buy sterling.
Lars Christensen
/ June 14, 2012“Nickikt, no I certainly do not support bailing out either bank or countries. I should of course have wrote that. The reason why I wrote that this is a “cool idea” is that is a fantastic illustration of how the monetary transmission mechanism works and that monetary policy is far form impotent.
So if you ask me the question what I would do if I was on the MPC of Bank of England then I would clearly have voted no to Britmouse’s suggestion. I but I 100% share the frustration that it reflects. That is why I wrote the comment in the way I did.
So again, no I am strongly against bail outs and I fear the consequences in terms of moral hazard. However, Spain’s problems – both in terms of public finances and the banking sector primarily reflects ECB’s tight monetary policy rather than banking or public finance failure. Has there been mistake made in terms and public finances and in terms of the banking sector? Clearly yes, but the main cause of the problems is a disfunctional monetary union and monetary policy failure.”
Becky Hargrove
/ June 14, 2012Sounds like a good ‘grassroots’ strategy – interesting!
Becky Hargrove
/ June 14, 2012I started to add, let’s keep that domino standing, and as soon as I went a few clicks away I could see the word domino was on other minds as well.
dwb
/ June 15, 2012see, i think Britmouse hit on the exact solution.
first, the UK should start with Cyprus because a lot of brits vacation there (the electrical is even UK-style as i recall), its strategic, its beachfront.
Second, i think Germany is thinking about this completely backwards. right now Spain, Italy, Greece, etc already owes Germany gobs of money.
They should buy all the southern EU bonds and *foreclose*. That would give all those hard working Germans a nice place with beachfront property to retire to. Kinda like the Arizona and Florida of Europe. The Greeks and Italians will need jobs, they can serve the Germans when they drive their Mercedes to the beach. I love Italian, Spanish, and Greek cooking. German, not so much. The Germans will eat really well in their retirement and on vacation.
Who cares how much it costs, it’s vacation, and if its retirement, you can’t take it with you anyway.
The Germans knew who the Italians and Greeks and Spaniards were when they got into this union. Now, they are chickening out at the altar.
I think they need to be more pragmatic about this and turn it to their advantage. Otherwise, against a paseta/lira/drachma they are going to work a lot harder to sell those Mercedes.
Diego Espinosa
/ June 15, 2012Lars,
What if Spain subsequently left the Eurozone? The British tax payer would have to recapitalize the BoE to offset the steep losses on Spanish debt. Effectively this is a suggestion to transfer risk from private actors to taxpayers. Reasonable people might label this “fiscal policy” that circumvents the legislative process.
There is one C.B. risk asset purchase case where risk is not transferred to tax payers. Where liquidity premia are highly elevated, central banks actually extinguish (by virtue of their irredeemable deposit base) liquidity risk by buying assets. In all other cases, an expansion of the central bank balance sheet in risk assets creates a contingent tax liability for taxpayers. This includes an expansion that results in higher duration risk (i.e. buying l.t. T-bonds). At the moment, the issue with interbank or sovereign lending in Europe is not liquidity risk but solvency risk.
dwb
/ June 16, 2012inflation is essentially a tax, a way to socialize losses. when we give the ECB (BoE, Fed) the power to print money we are essentially giving them the power to tax and transfer. Inflation is just a special tax that we call monetary policy.
If the BoE buys an asset, and the asset becomes worthless, cant they recapitalize themselves with more fiat money?
Diego Espinosa
/ June 17, 2012dwb,
An interesting question on recapitalization. The implication of reserve issuance is that a central bank can be insolvent but never illiquid. In practice, an insolvent central bank must react to increasing negative net worth by issuing reserves. Assuming demand for reserves is positive, this implies an insolvent central bank loses control of the money supply.
dwb
/ June 18, 2012maybe they can “lose control of the money supply” as you say, i am skeptical, however even if that is true, so what? MV=PY. i doubt V can drop to zero. As long as they only print enough money to maintain control of nominal income (and reverse such printing when warranted) i don’t see this as a problem.
Keep in mind: asset prices are a function of nominal aggregates.
i guess my overall point is that having the ECB (or BoE) buy stuff like soverign debt is basically a back-door fiscal union, and the “tax” to cover “defaults” is inflation (whether you prefer an inflation tax, VAT tax, tax, etc of course could be debated). The BoE or ECB will only need to “raise taxes” or create inflation to the extent necessary in order to offset velocity shocks. Of course, using ngdp targeting, then the market takes care of finding the right tax level itself and also I think velocity shocks themselves are much smaller if the policy is credible.
Lars Christensen
/ June 16, 2012Diego, I completely agree. The kind of monetary policy I want is not really this kind of shenanigans. I want a strictly rules based monetary regime. And guess that is what Britmouse wants as well. However, I still think his idea is a good illustration of how the monetary transmission mechanism works. See also my “update” in the post.
Diego Espinosa
/ June 17, 2012Lars,
I’d be interested in your thoughts on the more general point: central bank balance sheet expansion in anything but s.t. government paper results in an equivalent contingent tax liability for taxpayers. Further, any risk asset purchase can be replicated by 1) the central bank buying s.t. bills; and 2) the fiscal agent using the funds to purchase risk assets. Therefore, is risk-asset QE fiscal or monetary policy? I cited one case in which its clearly monetary policy: liquidity-restoring operations.
To
/ June 16, 2012I, for one, am all for bailouts. Look, if the political elite of a country cannot have a more or less responsible budget, they should be thrown out of the EU altogether. Yes, that applies to Greece. But Spain, Italy were reducing their debt burden before the crisis. Their only crime is to have entered the euro with higher initial inflation expectations than their northern neighbors, due to not having the insane monetary policy that killed the German and French economies in the 90’s. So Angela, stop whining and bail them out, you’ll make a profit on the operation !
And f***ing PRINT !