Adair Turner
Now that the pace of the US Federal Reserve’s “tapering” of its asset-purchase program has been debated to death, attention will increasingly turn to prospects for interest-rate increases. But another question looms: How will central banks achieve a final “exit” from unconventional monetary policy and return balance sheets swollen by unconventional monetary policy to “normal” levels?
To many, a larger issue needs to be addressed. The Fed’s tapering merely slows the growth of its balance sheet. The authorities would still have to sell $3 trillion of bonds to return to the pre-crisis status quo.
The rarely admitted truth, however, is that there is no need for central banks’ balance sheets to shrink. They could stay permanently larger; and, for some countries, permanently bigger central-bank balance sheets will help reduce public-debt burdens.
As a recent IMF paper by Carmen Reinhart and Kenneth Rogoff illustrates, advanced economies face debt burdens that cannot be reduced simply through a mix of austerity, forbearance, and growth. But if a central bank owns the debt of its own government, no net public liability exists. The government owns the central bank, so the debt is to itself, and the interest expense comes back to the government as the central bank’s profit. If central bank holdings of government debt were converted into non-interest-bearing perpetual obligations, nothing substantive would change, but it would become obvious that some previously issued public debt did not need to be repaid.
This amounts to “helicopter money” after the fact. In 2003, then-Fed Chairman Ben Bernanke argued that Japan, facing deflation, should increase public expenditure or cut taxes, funding the operation by printing money rather than issuing bonds. This, he argued, was bound to increase national income, because the direct stimulative effect would not be offset by concern about future debt burdens.
His advice was not followed; large Japanese deficits were in fact bond-financed. But the debts held by the Bank of Japan (BoJ) could still be written off. In Japan’s case, this would reduce government debt by an amount equal to more than 40% of GDP today, and around 60% if implemented after the bond purchases planned for 2014.
Objections focus on two risks: central-bank losses and excessive inflation. But both of these outcomes can be avoided.
Central banks have bought government bonds with money on which they currently pay zero or very low interest rates. So, as interest rates rise, central banks might face costs exceeding their income. But central banks can choose to pay zero interest on a portion of the reserves that commercial banks hold with them, even when they increase the policy interest rate. And they can require commercial banks to hold zero-interest reserves at the central bank equal to a defined proportion of their loans, thus preventing inflationary growth of private credit and money.
Permanent monetization of government debts is undoubtedly technically possible. Whether it is desirable depends on the outlook for inflation. Where inflation is returning to target levels, debt monetization could be unnecessarily and dangerously stimulative. Central-bank bond sales, while certainly not inevitable, may be appropriate. But if deflation is the danger, permanent monetization may be the best policy.
I predict that Japan will, in effect, permanently monetize some government debt. After two decades of low growth and deflation, Japanese gross public debt is now above 240% of GDP (and above 140% of GDP on a net basis); and, with the fiscal deficit at 9.5% of GDP, the debt burden continues to increase. According to the IMF, to reduce its net public debt to 80% of GDP by 2030, Japan would have to turn today’s 8.6% primary budget deficit (the balance excluding interest payments) into a 6.7% primary surplus by 2020 and maintain such surpluses continuously until 2030.
That will not happen, and any attempt to reach that target would drive Japan into a severe depression. But the government does not need to repay the ¥140 trillion ($1.4 trillion) of its debt that the BoJ already owns.
The BoJ will continue to increase its balance sheet until it achieves its 2% inflation target. Thereafter, its balance sheet may stabilize in absolute yen terms and fall slowly as a percentage of GDP, but its absolute size will probably never decrease – a likelihood that should cause no concern. It is precisely what happened to the Fed’s balance sheet after its wartime and postwar buying of US government bonds came to an end in 1951.
Even as permanent monetization occurs, however, the truth may be obfuscated. If government bond repayments to the BoJ continued, but were always offset by new BoJ bond purchases, and if the BoJ kept the interest rate on reserves at zero, the net effect would be the same as a debt write-off, but the fiction of “normal” central-bank operations could be maintained.
Central banks can monetize debt while pretending not to. That pretense may reflect a useful taboo: if we overtly recognize that debt write-off/monetization is possible, politicians might want to do it all the time and in excess, not just in circumstances that make it appropriate. The historical experience of Weimar Germany, or that of Zimbabwe today, illustrates the danger.
As a result, even when permanent monetization occurs – as it almost certainly will in Japan and possibly elsewhere – it may remain forever the policy that dare not speak its name. Such reticence may serve a useful purpose. But it must not blind central banks and governments to the full range of policy tools available to address today’s severe debt overhangs.
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