Debt Traps, Public and Private

Adair TurnerChairmanInstitute for New Economic Thinking

INET Plenary Conference Edinburgh 22nd October 2017

ineteconomics.org|facebook.com/ineteconomicsUSA300ParkAvenueSouth,5thFloor,NewYork,NY10010| UK22ParkStreet,LondonW1K2JB

InstituteforNewEconomicThinking

InstituteforNewEconomicThinking

Private domestic credit as a % of GDP: Advanced economies 1950 – 2011

1

Source:FinancialandSovereignDebtCrises:SomeLessonsLearnedandThoseForgotten,C.Reinhart&K.Rogoff,2013

InstituteforNewEconomicThinking

Textbook descriptions of banks and bank lending

2

Bankstakedepositsofmoneyfromsaversandlendittoborrowers

Bankslendmoneyto‘entrepreneurs/businesses’,thusallocatingfundsbetweenalternativeinvestmentprojects

InstituteforNewEconomicThinking

Share of real estate lending in total bank lending

Source:“TheGreatMortgaging”,OscarJordá,MoritzSchularick andAlanTaylor,2014)

3

10%

20%

30%

40%

50%

60%

Percen

tage

InstituteforNewEconomicThinking

Japanese government and corporate debt: 1990 – 2010

0

50

100

150

200

250

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Banklendingtonon-financialcorporates GeneralGovernmentdebt

4

Source:BoJ FlowofFundsAccounts,IMFWEOdatabase(April2011),FSAcalculations

%GDP

InstituteforNewEconomicThinking

Debt overhang : the unavoidable choice?

5

Sustainedlowgrowthandlowinflation– debtburdensnever

decline

Debterosionviaultralow

interestrates

Butleadstonewdebtcreation

Debtwrite-off,defaultandrestructuring

Buthasdisruptive/depressiveeffect

InstituteforNewEconomicThinking

Two policy questions

6

Howtoavoidgettingintothismess

How toget out

InstituteforNewEconomicThinking

Categories of credit creation and nominal demand

7

StimulatesnominaldemandFinanceofinvestment

Financeofconsumption

Financeofexistingassetpurchase

Stimulatesnominaldemand butrequiredjusttooffsetimpactofinequality?

• Nodirectstimulustonominaldemand• Couldjustincreasecredit,moneybalancesandassetpricing

• MaystimulatedemandviawealtheffectsandTobin’sQeffects

• Butnotcertainlyproportionaltocreditcreated

InstituteforNewEconomicThinking

Bank lending to real estate sector and prices Japan 1981 – 1999

8

-10%-5%0%5%10%15%20%25%30%35%40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%Commercial Land Price in the Six Major Cities

Bank Lending to the Real Estate Sector (R)

YoY%

Source:JapanRealEstateInstitute;BankofJapan;ProfitResearchCenterLtd;calculationsbyProf. RichardWerner,SouthamptonUniversity(seePrincesoftheYen,RichardWerner,2003)

InstituteforNewEconomicThinking

Credit creation for GDP transactions and nominal GDP: Japan, 1983 – 1999

9

Source:PrincesoftheYen,RichardWerner,2003

-4

-2

0

2

4

6

8

10

12

-4

-2

0

2

4

6

8

10

12

83 85 87 89 91 93 95 97 99

YoY %

Cr(L)

NominalGDP

YoY %

Explaininginstabilityandsecularstagnation| 10

Quantity theory of disaggregated credit*

NOT

But:

Sothat:

And:

∆M=∆P.∆Y

∆CR =∆PR

∆CNR =∆P.∆Y

∆M=∆CR+∆CNR> ∆P.∆Y

Velocityofcirculationstable

…where CR =credittofinancerealestatepurchase+

PR =priceofrealestate

…CR =credittofinanceGDPtransactions

P=pricesofcurrentgoodsandservices

Velocityofcirculationfalls

*SeeRichardWerner,NewParadigminMacroeconomics

+Ormoregenerallytofinanceexistingassets

InstituteforNewEconomicThinking

Monetary aggregates matter

Butnot becauseexcessiveMoneyisaforwardindicatorofinflation

But becauseexcessiveCreditisaforwardindicatorofcrisis,debtoverhang,postcrisisdepressionanddeflation

11

InstituteforNewEconomicThinking

Two policy questions

12

Howtoavoidgettingintothismess

How toget out

InstituteforNewEconomicThinking

February 20th 2016

13

InstituteforNewEconomicThinking

Nominal GDP growth and fiscal balance2007 – 2016

7.2

6.5

3.5

US

UK

Eurozone

2.8

2.7

1.5

US

UK

Eurozone

Source:IMFWorldEconomicDatabase,April2017;IMFFiscalMonitor,2017

GrowthofnominalGDP%p.a.

Averagefiscaldeficitas%ofGDP2008-2016*

(*)GeneralgovernmentBalance,Table1,IMFFiscalMonitor,April2017

14

InstituteforNewEconomicThinking

Two essential sources of nominal demand growth

15

Privatecreditandmoneycreation1

Sovereignfiatmoneycreation– noworexpectedinthefuture

2

InstituteforNewEconomicThinking 16

Dangerous

Forbidden

Freemarketensuresoptimal

result

•Essentialtodeliversomenominaldemandgrowth

•Canbecontainedbyrules

Sodangerousthatbanksshouldbe

abolished

Modernorthodoxy

ChicagoPlan

Fiatmoneycreation

Privatecreditandmoneycreation

•Statesfailbecauseofshort-termpolitics

•Marketsefficientandrational

•Bankcreditmarketsinherentlyinefficientandunstable

•Politicalprocessescanberational