Lord Adair Turner is challenging the belief that we need credit growth to fuel economic growth.
In his new book Between Debt and the Devil, Lord Turner – the UK’s Financial Policy Committee and former Chairman of the Financial Services Authority – explains that our addiction to credit was the underlying cause behind the 2008 global financial crisis. During a recent book launch at the New Economics Foundation, Turner illustrated the dangers of debt-fuelled growth while controversially advocating for direct central bank funding of government expenditure.
From the mid-1980s through to the 2008 financial crisis, advanced economies around the world experienced a period of moderate growth, low inflation and general stability. However, throughout this period, called the ‘Great Moderation’, personal, corporate and public debt rose relentlessly to fuel this extended growth. Levels of private debt more than doubled during this period, from 80% of GDP in 1950 to 170% in 2008.
Turner offers three primary drivers of credit growth in recent years; the first being the changing nature of banking and its links with the real estate market. The traditional role of banks – to take money from depositors and lend it to businesses for capital investment – has become an increasingly inaccurate description of modern banking. Today, banks create their own money and lend primarily for the purpose of purchasing existing assets (mainly housing and land). The limited supply of land combined with the extensive ability of banks to create credit creates vicious cycles which drive up house prices, encourage further investment in housing, and increase private debt levels.
The other two primary drivers are socioeconomic inequality and global imbalances in trade. Turner points to research which has shown that higher inequality leads to increased credit demand and indebtedness, as the poorest borrow more to achieve a median level of wealth or standards of living. Similar effects occur at a global level. The growth of export-oriented countries such as Germany and China has been fuelled by trade deficits and growing debt in import-oriented countries such as the UK and US. Reducing these imbalances would reduce global levels of public debt.
At the event, Turner illustrated how our traditional range of policy options have been rendered ineffective due to the largely unprecedented economic climate:
- Fiscal stimulus would stimulate growth, but at the cost of greater public debt and reduced financial stability
- Tight monetary policy or contractionary fiscal policy would hinder growth, potentially leading to deflation and a greater fiscal deficit
- Loose monetary policy options are limited – interest rates are near the zero bound and the low interest rates are simply encouraging more private borrowing (more radical policy options such as negative interest rates are an option but their effectiveness and the potential side effects are relatively unknown).
In the book, Turner advocates for the use of monetary financing (effectively printing money) to solve the economic puzzle of high debt and stunted growth. The immediate concern whenever the idea of printing money is floated is the fear of hyperinflation and reduced credibility in the central bank, as seen in 1920s Germany and modern day Zimbabwe. Turner claims that the risks of hyperinflation would be limited given sufficient coordination between the BoE and the government and given the implementation of rules curtailing its use. Simultaneously, he suggests increasing banks reserve requirements to limit their power to create finance and thus fuel asset price bubbles and financial instability.
Monetary financing could be achieved by the Bank of England buying public debt or by ‘helicopter money’ directly to consumers. Helicopter money is where the central bank prints money and sends it directly to everyone in the economy – it hails from an analogy made by the economist Milton Friedman in which money literally falls from a helicopter in the sky. In practice, the outcomes may be similar. The Bank of England purchasing public debt could allow for fiscal spending that increases income and spending, or money could be handed directly to consumers to reduce their debt and stimulate growth without the need for increased government spending. Both would have the desired effect of reducing indebtedness and providing an incentive to spend.
The Bank has recently warned that it must act ‘sooner rather than later’ to curb credit growth as consumer debt remained “large by historic standards”, leaving the UK economy “vulnerable to shocks”. The Financial Policy Committee (FPC) is currently considering raising capital buffers (alongside a wider range of tools) in order to reign in credit growth, as suggested by Turner. However, monetary financing hasn’t been mentioned as of yet, likely due to the difficult political nature of the tool. Concerns about breaching the Bank of England’s independence from government, the dangerous precedent set, and the risks of hyperinflation have meant that monetary financing has been seen as very much a last line of defence against threats to financial stability. However, given the current global economic outlook we may have few other options left.
To find out more about Adair Turner’s Between Debt and the Devil go to: http://press.princeton.edu/titles/10546.html