Well, if our own deficit is the Elephant in the Room, what is a nearby E300bn economy heading to bankruptcy?  Will future post-election commentators wonder what on earth the Guardian was doing running so many different columns on bigotgate while the next economic crisis burst upon our shores? (to be fair to the Guardian, they also have live blogging on Greece).

I hope it comes up in tonight’s debate.  Because the Liberal Democrat position on deficit cutting is, macroeconomically, the most sensible.  This letter to the FT today summarises the issues beautifully (from Prof Eatwell):

to what extent will deficit reduction result in the government “chasing its tail” as expenditure cuts result in falling tax revenues as a consequence of lower GDP and employment? Second, what is the true cost of the various measures, ie, the discounted value of the stream of GDP forgone? Third, how does this true cost compare to alternative fiscal strategies (reducing the deficit more slowly or more quickly)?

My spreadsheet attempted to illustrate his first point.  Try chasing some tail by downloading it.

How serious is the Greek situation?  Mohamed El-Erian of PIMCO points out how it threatens the private-sector:

The already material risks of disorderly bank deposit outflows and capital flights are increasing. The bottom line is simple yet consequential: the Greek debt crisis has morphed into something that is potentially more sinister for Europe and the global economy. What started out as a public finance issue is quickly turning into a banking problem too; and, what started out as a Greek issue has become a full-blown crisis for Europe

Is today’s news of a fall in credit demand from businesses and housebuyers signs that Europe is turning down, decisively? It is just a straw in the wind, but if you thought that a second phase of the financial crisis might be triggered by sovereign default hitting into banking balance sheets, would you be borrowing to invest or buy a house?  The Economist’s Ryan Avent is more phegmatic, and seems to rely on “Germans coming to their senses’.  Do you readers think this works?

A Greece restructuring is all but inevitable, but the cost associated with making Greek creditors whole is very small relative to the potential losses associated with continued chaos. … Right now the politics of a bigger German bail-out of southern Europe look deadly, but so did the politics of massive bail-outs of Wall Street financial institutions.

I think he ignores too easily how far we had to go down Crisis Lane to achieve those bailouts.  Making Greek Creditors Whole?  Are you sure?  Moral hazard, justice, anyone?  That would be toxic – not just for Germans.

But the most interesting analyses, for me, comes from Professor Nick Rowe, whose commentary here brings us back to what the Eurozone is really all about – money:

Only the European Central Bank has enough money to fix the Eurozone problem; because it can print it … (BUT) Who has the authority to say that the ECB may risk its seigniorage revenue on buying Greek or other countries’ sovereign junk, when that revenue belongs to all Eurozone governments? Nobody. The Eurozone is not a real country. There is no central fiscal authority behind the ECB. That decision would have to be reached by a political consensus of all Eurozone countries, and I don’t see that happening.

He then describes what may happen in terms that fans of Professor Scott Sumner will recognise – bank insolvency leading to a crisis of escalating money demand:

Eurozone commercial banks hold Eurozone government bonds as assets. With the drop in those bonds’ values, many commercial banks (inside and outside the Eurozone) will become insolvent. There will be (and already are) runs on those banks, as depositors seek to transfer their deposits to safer banks, if any can be found, or withdraw currency, if they can’t.  The first year textbook says this fall in bank deposits will cause a fall in the money supply, and that this fall in the money supply will cause a recession.

But the central bank is prevented, politically, from doing what it needs to: expand the money supply by buying up those government bonds.    His final prediction is intruiging – that sovereign states, having a shortage of Euros, will start printing their own currencies to pay their workers.   New drachma anyone? (Paul Krugman, imagining similar endgames, is now under the table).

How does this play for the UK? Well, our links of contagion are probably less. As Stephanie points out, we are a safe haven compared to Greece.  Check out the What’s In the Vaults Table: it’s French banks who might be in trouble here.  For once, our bankers didn’t get stuck in.  And our economy beats to different rhythms: check out the bullishness about private sector hiring from the CIPD today.

But every party is relying on ‘rebalancing’ – more exports, basically – and how can that happen if Europe is in a panic?  I hope Clegg makes the point powerfully: unlike our Conservative opponents, we don’t believe that cutting back,  in all circumstances and at all times, makes the economy stronger.  And (this is a long-shot) – we need to be more vigorous with the money-medicine if we do teeter into a Double Dip.  Like a wise man once said.


18 thoughts on “Ignoring the Hippopotamus next door …

  1. I’m a bit confused: are you advocating engineering a transition to a new equilibrium with less real output and less government debt (for the UK)?

    Re Europe: interesting that Rowe should be suggesting what is basically Warren Mosler’s plan from a few months back: a massive fiscal injection. No sense of irony there!

    Also a bit thrown by the monetarist terminology. How would buying up Greek bonds expand the money supply? Surely it would just make the holding banks’ portfolios more liquid & support asset prices. I.e., it might prevent banks from going under, but that doesn’t strike me as being the same as “expanding the money supply”.

    1. Sorry, mutual confusion: how is creating reserves and buying bonds not going to expand money? Of course, if it is only off the banks then perhaps. ..

      And how is Nick Rowe a fiscal booster? I am being a bit late-afternoon slow.

      I am not advocating any particula transiation here. If I have a general aim it is to get nominal GDP higher, and use assurances of a very loose money supply to do this.

  2. Also, isn’t a fall in the money supply basically the generic rememdy for Britain’s ailing finances–basically the recommendation of all and sundry? If the governemnt hoards liquidity, its finances will improve even as income falls.

  3. vimothy: “Re Europe: interesting that Rowe should be suggesting what is basically Warren Mosler’s plan from a few months back: a massive fiscal injection. No sense of irony there!”

    No sense of irony at all. When it comes to increasing aggregate demand, I can’t really see any difference between Warren Mosler and traditional monetarism. The only difference is what they call it. Warren Mosler calls it “fiscal policy” and monetarists call it “monetary policy”. Which (understandably) confuses people (including MMTers themselves). In both cases we are talking about “helicopter money”, even though MMTers hate the phrase.

    I did a post on this a while back.

    Good post freethinking! Like you, I can’t understand how anyone could be worrying about anything else, at the moment.

    1. Hi Nick

      Many thanks. For the enlightenment of the people on this blog, is your helicopter post one of these?

      The latter post and its ensuing discussion were so useful to me that I felt I had to acknowledge them in the footnotes of my amateur opus on QE (note 103!) that the Financial Times quite liked.

      But my views on Helicopter money and its meaning were as much influenced by footnote 11 on the IMF document on unconventional policies, where he wrote:

      Although this proposal would constitute one particular form of quantitative easing, it can be decomposed into a familiar operation already covered (money-financed acquisition of a claim on the government) and an unconventional element that, however, amounts to fiscal policy (debt-financed transfer to the public).

      Does everyone agree? Helicopter money is fiscal and monetary policy working together par excellence. Does this explain how you and Vimothy might both be on the same track?

      My problem with making a permanent-money-injection recommendation is that it seems so irresponsible. Consider the political economy: we have a leftish government that spent too much in the good years, lacking discipline. A supposedly liberal writer (me) comes out with “Don’t worry: the answer is to print money and give it away, thereby increasing expectations of future NGDP*”. I’d feel like someone denying gravity. Do you have any views on how such a policy is best ‘sold’. politically?

      * Being a fan of Richard Koo I also think it works in the fiscal way – lightening the balance sheet strains of the private sector. But again it seems something-for-nothing, and the irate response of the savers’ lobby would be something to behold …

  4. Nick, it isn’t that they hate the phrase, it’s what the phrase represents. Monetarism assumes that there is this exogenous “thing” called the money supply. In response to a contraction, enlightened central bankers can increase it, which raises nominal income, because the same amount of real output is now divided up among more bits of paper. Problem solved–go monetary policy! The helicopter drop crystallises this view with an image of the CB literally pouring money onto the economy from up high.

    The MMT point, at least as far as I understand it, has always been that this isn’t monetary policy! The helicopter drop is fiscal policy. And we all know how everyone feels about fiscal policy. Fiscal policy is naughty, and people who use it should be sent to bed early. Monetary policy sets the price of funds, generally just by announcement (helped by anticipatory arbitrage), but also by insuring that the system has enough base money / reserves to meet demand. You can swap every government bond in the banking system for base money and you wouldn’t be any closer to your goal. Net asset position would be the same, just more liquid. So the bankings system lends and borrows clearing balances at a low rate, but if there is no demand for credit…. Well, see Richard Koo.

    A helicopter drop would be a fiscal operation with no offsetting bond issuance. It would place downward pressure on the CB’s target rate (which is why, in the MMT narrative, fiscal policy is accompanied by bond issuance–its an “interest rate maintenance account” in MMT jargon), but it would ensure that everyone is disabused of the notion that government borrowing funds its spending, and it would deny the bond market its corporate welfare.

    Of course, the fact that there is no central government in the EU like the federal govt in the US who can do this (only a constrained central bank) combined with an effective gold standard is precisely why there is such a massive problem.

    Insofar as the correct response to inadequate effective demand is to increase it, then I agree that there is some overlap between monetarism and MMT and post Keynesian economics more generally. It’s just everything else that we disagree on!

  5. The ECB buying members bonds from the local banks would not increase the money supply. However, buying them direct from the Treasury departments would increase the money supply.

    Although the problem is the ECB has no legal authority to buy government paper. Each member country has a shareholding in the ECB. Therefore, the largest states would see themselves as being on the hook at least nominally for the greater amount. However, Germany and France would in effect be bailing out their own banks and not just the eurozone periphery. Unfortunately local politics would not appreciate this point. Moreover, Germany constitutionally would be legally required to withdraw from the eurozone if the ECB started bailing out members by buying government bonds.

  6. Hi Giles: I was thinking of this post, on “Modern Monetary Theory” (aka Neo-Chartalism) and monetarism:


    “Does everyone agree? Helicopter money is fiscal and monetary policy working together par excellence. Does this explain how you and Vimothy might both be on the same track?”


    “Do you have any views on how such a policy is best ‘sold’. politically?”


    vimothy: “A helicopter drop would be a fiscal operation with no offsetting bond issuance.” Agreed. Literally, it’s a money-financed increase in transfer payments. Because the new money is just given away, rather than exchanged for anything.

    There are really two questions:
    1. The semantic question, of whether we call this a “fiscal” or a “monetary” policy.
    2. Whether what matters most for aggregate demand is the fiscal bit or the monetary bit.

  7. Nick:

    I certainly feel that if the government literally handed out $0.25tn (or whatever) in newly printed cash, the recession here would be over. It could call this monetary policy, fiscal policy or tactical financial counter-insurgency for all I care.

    But the helicopter drop is obviously not monetary policy; it isn’t anything like monetary policy. Monetary policy sets a rate for funds by announcement supported by operations swapping less liquid interest bearing assets for more liquid non interest bearing assets or vice versa via repo. It does nothing for the net worth of the recipients. It prints (a particular form of) “money” but only as it simultaneously shreds another form of money (during the repo). Scott Fullwiler:

    “So, here we have an interesting fact: UNLIKE EVERY OTHER monetary policy operation, BUT LIKE EVERY OTHER fiscal policy operation (with or without bond sales), helicopter drops of “money” as shown in Figures 1 and 2 raise the net worth of the non-government sector. Therefore, I (and my fellow bloggers on this site) argue that it is more appropriate to label helicopter drops as FISCAL operations, NOT monetary operations. ”


    This matters insofar as the nice images we spin of monetary policy do not accurately represent what happens on the ground. The CB doesn’t control the money supply by expanding or contracting the monetary base. The money supply is mostly private debt contracts. Insider money. CB can influence price of this money, but quantity is demand determined, so there is no “monetary bit” to the helicopter drop (note that monetary policy doesn’t increase supply of outsider assets either, just alters their composition). If we want to “expand the money supply” then we really need fiscal policy, which can actually increase “money” regardless of agg demand for credit by supplying outsider assets that raise net worth of private sector. Monetary policy is generally an unsuitable instrument for macroeconomic management in such a crisis because it’s just pushing on a string.

    It’s frustrating that this is at once such a trivial semantic point and also so fundamental, but there it is.


    To hell with the savers lobby! The problem with listening to them is that what we are left with is a smaller pie (less real goods and services) and their increased claims on it. This is not good for society as a whole. Equally, the government should not be hoarding liquidity. In fact, putting both your suggestions together, it seems like you are angling for the government to hoard liquidity (“pay down the debt”), and then an expansion of private debt (“loose money supply”) in order to offset the fall in aggregate demand and real output caused by the govt’s short squeeze. This is not a sustainable arrangement, do not pass go, etc, etc. If the loose money policy does not work, then we have to settle for lower output—swapping nominal gains for real losses, and all because of some venal idiots in the financial sector and incompetent regulators in the public sector. Fair? Vote for X because they’re honest about cutting the most public spending?

    Just been watching a load of talks from the Milken conference with our much vaunted business leaders. Amusing just how predictable those guys are (Steve Forbes is hilarious). They have one idea as well… deflation. That’s it, basically—the extent of their solutions. Plus ca change…

    Interesting paper from the IMF, though. Cheers for posting that. I disagree that the helicopter drop is QE. QE is more clearing balances to the financial sector in the hope that this might spur lending, i.e. monetarism in reverse. Of course, it doesn’t work like this in practice (Koo, e.g.).

    1. First, thanks again for the useful links and a blindingly good comment here.

      You say ‘to hell with the savers lobby’. Well, easy to say, but you have just evaded the problem. I had a talk with 8 prospective Lib Dem candidates. All of them, when we discussed interested rates, said that the ‘doorstep’ sentiment is about rates being too low. This is a problem. But short of nailing the doors shut to stop them voting, it is one that needs a good communication strategy.

      On to my recommendations: I think we are in a special place right now, and the policies of the AD UP brigade make perfect sense for this special moment. But we may be 5% short of the kink in the AS curve – and then what? We will still have a structural deficit, which will in various ways bear down on our ability to grow. It needs to be addressed AT SOME POINT, and making the plans now, to do it later, is not lacking in sense, and might under certain Ricardian ways of looking at things (see Andrew Lilico’s points) boost confidence now – which is what we all need.

      So I agree that there is a weakness in my view: private indebtedness which may not be able to bear the burden of increasing demand enough. I have not worked out what to do about that, in all truth, and perhaps straight transfers like the Helicopter would help. But if house prices lurch down again, then what? A fall of 20% = 800bn. Can we fill that gap with printing?

      1. “Interested rates” is an excellent spelling mistake!

        Agree that low rates impact unfairly on savers. In fact, I think I made this point apropos aggregate effects of QE on savers (reducing interest income, so net effect on a depressed economy possibly a wash, possibly even worse if you ignore asset prices and consider effects on fiscal deficit) on this site a couple of month ago.

        But this is precisely because monetary policy is seen as the royal road of macroeconomic management. That little policy rate is meant to moderate aggregate demand, keep growth steady, fight inflation, prevent unemployment, etc, etc. Now apparently it is also supposed to reflate bubbles and prevent bubbles from forming. Poor little over-worked instrument!

        Rather than seeking to mitigate demand deficiencies by nothing other than reducing the price of credit and encouraging the private sector to lard up on debt—and reducing the interest income of savers/lenders—it would be better for the government to net spend. This would raise effective demand, employment, real output, etc, and provide liquidity and savings to those with a propensity to accumulate wealth or liquidity. And we could put our idle resources to good use on countless tasks. We don’t lack need.

        You can tell savers that this is in their interest because it holds aggregate income constant while they hoard. Otherwise, their hoarding is rather pyrrhic (in terms of the whole—of course there may be those individuals who benefit from deflation in relative or even absolute terms). You can tell ‘em that they will have a higher net worth as a result of the net spending / helicopter drop. They are savers after all, so this will make them happy.

        If no one makes these arguments but instead feeds the irrational beast with mad and impossible dreams of the government acquiring a huge store of liquidity that will collectively make the country better off… We’re going to end up like that golden child of European fiscal responsibility, Estonia.

        Think that you see the problem quite clearly in terms of deficient aggregate demand and falling nominal income, and we are in total agreement in diagnostic terms. Disagree somewhat with the LRAS curve constraint and the notion of the structural deficit, or at least feel that this needs some unpacking. Wholly disagree with Lilico’s pre-Keynesian Say’s Law and Loanable Funds theory of the interest rate humping analysis, but I doubt that’s news to you.

        Govt deficit just reflects accumulation of wealth. “Structural deficit” is the deficit we had before the crisis. Well, from about Q1 02 corporations went from deficit to surplus and the government went from surplus to deficit. Since then we have seen the household sector finally get into a moderate surplus position and the corporate sector increase its surplus even more. The deficit has effectively been redistributing that saving flow back into the private sector.

        If you get to the stage where there is no deficit, then there is no private net saving. Why should this be thought of as a good thing? Furthermore, how do you know that total income will not move when you try to cut the deficit (i.e. that savers will simply stop saving in line with your budget projections)?

      2. Oh and what will your LD MPs tell their consituents then? Sorry, you’re not allowed to save at all because we need to cut the structural deficit…?

  8. vimothy:

    A thought-experiment, that will maybe help us get around semantic and other disputes.

    Suppose (just so I can tell my story) that the government can’t create money out of nothing (I know it can, but suppose we are back on the gold standard, or something).

    A good fairy grants the Australian government one wish: it can either helicopter households money that the fairy has created, or it can helicopter households real goods and services that the fairy has created. Same value in either case. In both cases the net worth of households rises by the same amount (at the existing price level). Which does the government want?

    In normal times, the government should choose the second option, since the first would only cause inflation, while the second would increase real wealth. But in a recession, where there’s a shortage of money, I would argue for the first.

    It’s not just the dollar value of the transfer payment that matters. It’s the fact that it comes in the form of the medium of exchange. A helicopter drop of bonds, for example, wouldn’t work as well.

  9. Vimothy:
    “You can tell savers that this is in their interest because it holds aggregate income constant while they hoard. ”

    Sorry, but it’s the doorstep, not an IFS seminar. Its an old lady. She has a fixed nominal income, which she saved for, and inherited. She wants 5%. She hears that the government wants to drop a load of cash on the feckless. I say what exactly ….?

    No matter how formally correct, more people believe the Redwood-simplistic view that govt deficit reflects feckless bureaucrats, than “Govt deficit just reflects accumulation of wealth.”

    1. The bigger the lie, the more they believe?

      So here we have an interesting problem. You could tell savers the truth, that the deficit facilitates their saving; or you could tell them a lie, that the deficit is just feckless profligacy. Probably get more votes for the lie and the destruction of public wealth, but you won’t get more saving.

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