When and How PQE/Helicopter Money can Lower Inflation

The Debate

I can’t resist a challenge.  As part of the ongoing debate on ‘people’s QE’/Corbynomics being used to finance government investment there was a guest article on Coppola Comment, describing it as ‘snake oil’, by Paddy CarterThe gist of the article being that an inflation targeting central bank would automatically offset any state (helicopter) money creation.  This struck me as a curious argument as in any such regime the central bank would operate under a different policy rule, and more importantly the author had assumed rather than demonstrated the key issue – whether it would be inflationary.  It seemed to me that if the new money was purely spent on investment in productivity improvements then it would not be inflationary but deflationary.  I tweeted this, there was some response on twitter including from Richard Murphy, and from Francis Coppola, challenging me to ‘math it up’.

I don’t think this is too shocking a position whatever school you follow in modern economics, almost all of which would disagree with the crude monetarist doctrine that inflation is due to ‘too much money chasing too few goods’  – a doctrine which neglects the prime importance of where the money goes to and where it is spent.  Even the most NK orthodox such as a corridor sharer with Tony Yates would agree that if consumers expectations as to the price level were depressed because of investment which increases capital intensity and increases productivity, thereby increasing the amount of goods being chased by money, then they would have to agree, that if carefully targeted, that state money creation would be, at the very least over the medium term, deflationary.

Francis is in lucky in that I had already made a start – following a challenge from Dirk Bessemer – on formalizing a model of state money creation.  They key issue here is mechanical production of money is easy – you print it or credit an electronic account.  What is harder (to paraphrase Minsky) to explain is why that unit of account has value and what the relationship is between the volume of the unit of account and the price of goods and services.  Holding and using different state currencies is not costless – using some will incur liabilities such as tax as well as exchange loss.  So understanding how and why a portfolio holding is established in a currency cannot be done so without understanding the corresponding counterbalancing ‘liquidity services’ that the holding grants to the portfolio holder.  Central amongst these is the ability to consume, trade or invest in innovative goods and services being produced in that currency area.  It is not the monopoly power of money creation by the state by itself that creates seignorage – that is a necessary but not sufficient condition – but the ability to create revenue because of the arbitrage between the ability of a monopoly currency issuer to issue the unit of account at zero production cost and the revenue to be obtained from investing in new goods and services priced in jurisdiction that unit of account.  So providing new money is thoroughly ‘backed’ by these goods and services creation of that money is not inflationary; indeed it can be deflationary.

What follows is an approach which attempts a synthesis of a number of streams of monetary thinking – such as Cartelism, circuit theory, MMT, the backing theory of money (the inverse of monetarism) and Keynesian monetary theory – but is none of those.  However whatever your background, even DGSE and rational expectations, what I am saying is not so shocking if you think about it.


The Base Monetary Model – Tax and Spending in Balance

A golden rule is that all monetary models need to be expressed in double entry terms and meet the fundamental equation of accounting.  That is assets = equity + liabilities.  Anything else truly is theoretical snake oil.  There are those who argue this doesn’t apply to central bank money creation.  That these can create money ex nilhlio without backing by equity – quite unlike private banks.  Those who argue this are making a fundamental error and making the extraordinary claim that the most fundamental equation in economics is not universal.  An extraordinary claim requiring an extraordinary explanation.   Of course I could set up the central bank of Pimlico (after declaring independence) tomorrow, but unless its issuance of units of account is ‘backed’ like all new monies this would just be so and so  much valueless paper.

The first of these is a pure monetary steady state model of state money creation.

Here a central bank issue new state money to the state to spend, which is then spent in the private sector.  This is exactly counterbalanced by the state issuing a tax demand to the private sector of exactly the same amount and the tax and spending exactly cancel each other out.

This is the simplest possible model of state money creation and taxation. It assumes no regulatory constraints- as for example in the treaty of Lisbon – on state money creation.  More realistic models can be constructed on the back of this base simple model – for example with a debt management office issuing gilts and bonds.  In balance the net effect is the same – tax balances spending and there is no overall effect on the price level of state activities.  This has one enormous simplifying assumption.  All spending in the economy is revue only – no capital spending.

This simple model has one striking feature – the State spends money into existence and taxation destroys it.  This seems counterintuitive – which simply confirms the power of this circuitist doctrine.  To think of wealth as a ‘hoard’ which you get by sitting on it – what I call the Smaug doctrine – is the powerful fallacy in all of economics.  Indeed Adam smith based on his career on falsifying a version of it and created modern economics as we know it in the process.  It is possible to accumulate wealth by sitting on it but never to create it.  New wealth, and the money which creates new wealth, is always and everywhere spent into existence.  Looking it in terms of assets and liabilities, in terms of modern money, this is undeniable.  The mistake people make is to confuse the physical token of money, coins or cash, with the underlying circuit of accounting transactions.  It is not the token which as value – look at a confederate note – but the participation of that token in the monetary circuit.  All that is being recycled when you respend a coin or cash is the token – it is the ability of the state to drain money reserved to neutralize the aggregate demand impact of new money creation –  which maintains the face value of that note.


The Base Physical Model – Taxing a Surplus

Now the simplest possible physical model of taxation.  A one good model, such as corn.

There is a surplus of corn so that physical input of C produces C’.

This surplus can be taken as rent by the landowner.  However imagine in the model a state which imposes a tax liability on the farmer.  The farmer now either has to increase productivity in order not to starve or the landowner has to reduce their rent to maintain any surplus.

Here we can see tax for what it is – a form of economic rent – by a factor holder – in this case the state – in that one critical but neglected factor of production is money.  Money historically often being forced into circulation by states imposing debts – tax liabilities.

The Base Growth Model – Labour Saving Technology

Finally we shall consider the simplest possible economic growth model.

Again we have one physical input and one physical output.  In the base case there is no fixed capital.  There is a small surplus.

An innovation – in the form of fixed capital promises to raise the productivity of output by a not insignificant amount.  Creating this innovation requires dedication of labour to create the fixed capital, the new good, rather than the new one.  This will take a number of months and a certain amount of labour.  This is an essence a very classical model of fixed capital formation.

Here there is a very clear mathematical relationship between the increase in the rate of productivity of the machine and the amount and length of time it takes in forgone surplus in the original process.

The present value of the investment is found from the perpetuity formula FV (future value) / (1+r) where r is the discount rate (cost of investment} there is a mathematical relational ship between the rate of innovation and the rate of interest where investment is viable, space and the need to avoid a too technical explanation means this is better discussed in detail elsewhere.

Put most simply however In those cases where the interest rate islower than the increase in the rate of physical surplus from the innovation there will be a growth in credit until the excess profits from the innovation are eaten away back to the general rate of profitability.

If some of the psychical surplus is further invested we get compound growth.


Pulling the three models together

The creation of an innovation allows the capitalist who exploits it to charge a Schumpeterian rent to prices and earn super profits.  The demand for the good creates a demand for the currency in which the good is produced from consumers, as well as from investors seeking a slice of the action.  This creates the potential for seignorage in that currency.

If the units of account does not expand then after the innovation that monetary base remains fixed but the amount of goods increases.  This deflates prices.  This is not necessarily a bad thing for the consumer.  However for investors each % fall in real prices is an additional % in the rate of surplus needed for an investment to make a profit.   Why invest money if by sitting on it you can buy more good in the future?  This is the curse of innovation with a fixed peg- like the gold standard.  A burst oi innovation eventually completely loses steam as the fall in prices caused by the growth is eaten away.  Eventually we get the growth runs out – a business cycle.  Credit taken out on the assumption that growth will continue may be unpayable.

There is a solution.  If the issuer of the unit of account expands the monetary base by precisely the amount of the rate of increase of the surplus then profits don’t fall.  Indeed there is a market mechanism to do so.  As a state can issue new money at zero cost then there is a market incentive for it to do so to earn the seignorage from investing it in the new technique.  Then it earns a piece of the action.  Providing the rate of increase in new money precisely equals the rate of increase in the surplus, the new money will precisely counteract the rate of deflation caused by the economic growth.  It is entirely possible for the state to create new money and there to be deflation if the rate of investment is less than the rate of growth.

An objection might be raised as why the state should be investing, the market will chose the optimum investment globally.  Globally is the issue.  Capital from innovation need not flow back into investment in that sovereign currency area, it can go anywhere and might not benefit residents of the area at all.  Whereas state money uniquely must first be spent in the sovereign currency area to exist at all.

Policy Implications

This discussion implies a golden rule.  If net state money creation is solely used to invest in productivity improvements, and at a rate less than the discounted rate of productivity improvement,  it will not be deflationary.

The problem is it is very tempting for any government to spend state money on revenue, paying down old debt or on productivity reducing investments (arguably healthcare where an increase in spending led famously to a reduction in productivity under Blair).  If state money creation is simply used to prop up state revenues and pay normal bills there is a risk of inflation and in the worst cases hyperinflation.

The solution is to recast the role of an independent central bank.  Instead of running an inflation or nominal GDP rule it runs an investment rule, creating money and spending it on projects at a rate and in areas which it considers will maximize the rate of economic growth.  The central Bank again becomes the state investment bank – its historical role.    With such iron discipline Corbynomics would work in normal times not just times of crisis when helicopter money is gradually becoming accepted as a useful tool.

There are many examples of investments which would boost productivity.  Notably solving the acute shortage of housing in this country, investing in energy efficiency, training, rail improvements etc.  This is not to say that there are other useful things for the state to spend on, but these need to come from the results of growth.

There is a problem of timing. A project that might boost productivity in 5 or ten years will be boosting aggregate demand now and if there are some goods in the investment that temporarily in short supply these might add to inflation. The solution is to tax the superprofits and rents/or wages of those that get this boost readjusting aggregate demand.   If expectations get out of kilter and consumers don’t adjust their spending and savings to account for future wealth and falling prices as opposed to temporary raised incomes and rising prices then temporary increases in consumption taxes may need to form part of this policy package.


Hammersmith Conservative Councillor wants to knock down Listed Buildings

Harry Phibbs in Conhome – stark raving bonkers imposing his narrow aesthetic on everyone else irrespective of the law – cultural fascism in other words.  I dont mince my words as only fascists wish to knock down buildings with which they have an ideological disagreement with and then distort their aesthetic to match – read any book by Roger Scruton for example.

The spirit of localism should mean that if local residents and their elected councillors wish to get rid of a hideous tower block spoiling the skyline they should be able to do so. However in some cases it is not possible because a block has been listed by English Heritage (now renamed Historic England).

There has been much rejoicing over the decision not to list the brutalist Robin Hood Gardens in Poplar – it can now be knocked down.

But what of those eyesores that are listed? For instance the Park Hill flats in Sheffield (right) or the Trellick Tower in Kensington (left). Or Byker Wall in Newcastle (below right) or Keeling House in Tower Hamlets (bottom left)).

Trellick-TowerEnglish Heritage is supposed to:

“Promote public understanding and enjoyment of the historic environment.”

It is hard to see how forcing the retention of eyesores (often with hefty repair bills) fits in with that brief. An organisation that should be trusted as an ally of beauty and tradition has betrayed that trust.

Listing buildings is not their only role. But for them to exercise such staggering poor judgement does cast doubt about their credibility more widely.  For example they boast in their report for last year:

“We gave constructive conservation advice on 21,942 planning cases this year, focusing our advice on preserving the best of the past whilst exploring opportunities for positive and creative change. 

“At Girton College, Cambridge, a new wing comprising 50 en-suite bedrooms opened and the College’s listed swimming pool was refurbished. This successful modern intervention received a RIBA regional award in 2014.”

The Girton College development looks awful – no surprise that RIBA gave it a prize.

bykerwallThis is a Quango which gets £100 million of taxpayers money a year – via the Department for Culture Media and Sport. But how accountable is it? Supposing, for instance, it was proposed to delist certain buildings (such as some of those illustrated here) in order that they could be demolised? What is the mechanism for that review?

keelinghouseA spokesman tells me:

“Once a building is listed. It stays listed.”

The spokesman later elaborated:

“Anyone can apply for a building to be de-listed and they can do that through an online application form. All buildings are listed based on their architectural and historical importance. To get a building de-listed, the applicant needs to prove that what made that building “listable” is no longer valid. It may be a place has been damaged and has lost the elements of the building that made it eligible for listing in the first place. Or it may be that the building has, for example, been wrongly attributed to an architect and if they can demonstrate our original research was wrong, it would also be considered for de-listing.”

That is unsatisfactory. If the decision was quite mad in the first place it should be ditched – even if the facts have not changed.

Osborne’s ‘Any Village in England has a freedom to expand’ doctrine

In case you missed it in the rural productivity plan, any village implies in Green Belt as well naturally.

The government will increase the availability of housing in rural areas, allowing our rural towns and villages to thrive, whilst protecting the Green Belt and countryside. This will include a significant contribution to the 200,000 ‘Starter Homes’, to be offered at a 20% discount for first-time buyers under the age of 40, that the government is committed to delivering this Parliament. Through the right combination of measures, the government wants to ensure that any village in England has the freedom to expand in an incremental way, subject to local agreement. In addition to carrying out the review of planning constraints in rural areas [business pd rights] mentioned above, the government will:

• Ensure local authorities put local plans in place for housing according to agreed deadlines and require them to plan proactively for the delivery of Starter Homes. The government will also bring forward proposals to speed up the process of implementing or amending a plan.

• Help our villages to thrive by making it easier for them to establish a neighbourhood plan and allocate land for new homes, including through the use of rural exception sites to deliver Starter Homes.

• Review the current threshold for agricultural buildings to convert to residential buildings.

• Introduce a dispute resolution mechanism for section 106 agreements, to speed up negotiations and allow housing starts to proceed more quickly

How a Chinese Equity Black Monday Transmits to a Global Money Supply Collapse

China’s stock markets are having a really bad day. A black Monday, down 8.45%, with knock on falls in closely intertwined markets such as Japan and Australia- and now spreading globally.

There are still those that doubt whether a stock market collapse has an impact on ‘real’ economies – so it is worth spelling out precisely the transmission mechanism via the banking system.

Stock market bubbles are fulled on speculation – on what Guzman and Stiglitz (2015) call tellingly ‘pseudo wealth’.  It is the collapse in that pseudo wealth that causes aggregate demand collapse in the wider economy.

The transmission mechanism is through the banking system, principally through the collapse in the perceived real value of equities and company assets held as security on loans.  Collateral enables banks to leverage their ability to lend – their ‘lending power’.  Banks are not passive intermediaries they can create money at the stroke of a pen, but not without limit.  They need existing assets (equity) and then leverage those assets depending on the collateral lenders provide and future perceived income streams from lending.

When perceived future revenue streams provide to be pseudo-wealth then this has a strong feedback loop on the ability of banks to lend.  Non performing loans increase and banks can leverage less with less collateral to bank their existing loans books.  The ability of banks to lend – their lending power – their ‘charter value’ as it is known collapses.  From levering we go to deleveraging and the familiar debt deflationary cycle described famously by Fisher and elaborated by Minksy, Steve Keen and others.

In good times banks expand the money supply, but this is not deflationary as the money is destroyed on repayment of loans and if the investment is used to reduce factor inputs it may raise wealth and even deflate prices increasing real wealth.  If however the loans are spend on assets and ‘pseudo wealth’ the repayment of debts in a downturn becomes purely deflationary not backed by increases in productivity and we get a depressionary cycle.

This is why an equity collapse, in a highly leveraged economy, can have non linear impacts on money supply and growth.  In China a collapse in formal bank lending will also have a knock on impact on shadow banking because of the carry trade to less well regulated shadow banking.

Can the global economy cope with a trillion dollars knocked off equities in one day? What matters though it how leveraged that equity is.  The answer is straightforward; it is highly leveraged and no it can’t.

Their is only one possible response for the Chinese authorities.  Flood the Chinese banks with ‘helicopter money’ to prevent a banking collapse, it that leads to a collapse in the Yuan so be it.  The global response has to be to avoid a ‘currency wars’ response.  This is precisely what was done to the Japanese banking system in the Great Depression and worked well compared to the dramatic austerity in Europe for example in the same period.

Their would be some irony then if China and its closely interlocked economies saw their savior in an economic measure derided as ‘Corbynomics‘.

Who Will Take Over from Anchorman at DCLG? (They wont be an LG Chief Planner)

With the sad news (as a lonely voice of sanity at DCLG) that Chief Planner Steve Quartermain is to move on to Pins who will take over?

It used to be the case that the chief planner at Brum or Newcastle or wherever would step into such a job.

Very very unlikely and inadvisable.  Why?  Because as the chancellor has flagged English planning is at the cusp of transformational change to a zoning and subdivision system.  What is needed is an expert at such transformational change.  So even the star planners or managers of planners in England – such as Waheed Nazir , Emma Peters, Fiona Fletcher Smith, Alice Lester or Barra Mac Ruairí, I dont think would get a look in.  If you are a chief planner whose main achievement on your cv is keeping Councillors happy rather than getting houses built don”t even bother asking for an application form.

Far more likely would be a former chief officer at somewhere like Vancouver, Seattle, Abu Dhabi, Melbourne or Singapore, or an associate in firms working in such sectors.  Someone like Brent Toderian, Larry Beasley, Jeffry Ho, Jerome Frost or Anna Reiter (my tip).  The DCLG would really need to dip into its pockets to attract someone of such international calibre though, and in doing so would signal that it valued planning and planners.


Osborn Proposes More Rural Planning Reforms

In the telegraph – with Liz Truss – all re-announcements

More and more of us are moving from city to countryside. According to the latest Government figures, predominantly rural areas in England are experiencing net internal inward migration of more than 60,000 a year. It’s a social trend that makes Britain almost unique among developed economies, which see mostly rural to urban migration. This Government is determined to support the millions that already choose a rural life and those that are joining them.

…we’ll look at planning and regulatory constraints facing rural businesses. In a recent survey of rural businesses the main barrier to growth that most identified was planning restrictions. So for a start, we’ll review rules around agricultural buildings such as barns to allow rural businesses to expand more easily.

…And if we are going to attract and maintain a dynamic workforce, we need to make it easier for people to stay in their rural communities and for newcomers to settle there too. We’ll always want to protect our green belt and beautiful natural environments, but the lack of housing in rural areas is a scandal. Those living in villages want to see them thrive, want to maintain enough housing for their children to live in and want the local shop, school and village services to flourish. So we will reform planning laws, making it easier for villages to establish their own neighbourhood plan and allocate land for a small number of new homes.



Clark Unikely to Conclude Local Plan Examinations Himself if it Means Green Belt Dedesignation

Why has Greg Clark refused to step in and complete the Warwick Examination after the inspector had a preliminary conclusion of unsound through lack of providing OAN?

My theory is the realisation has dawned after ploughing through the West Somerset Papers that getting a plan adopted means either Green Belt loss or not meeting OAN itself – forcing it on others – and that he would much rather let LPAs do this.

This also means I think he lacks the balls of steel necessary to take over local plans if they do not meet the yet to be announced cut off date for submission.

The result should not surprise Warwick complaining of ‘spending the next two years resolving Coventrys housing problem’ when the reality is they have spent the last four years avoiding taking their fair share of Coventrys housing problem and are now paying the consequences.