Central banks should be prepared to break the ultimate monetary taboo and directly finance government's deficits, the chairman of the Financial Services Authority, Lord Turner, suggested in a speech last night.
Lord Turner said “overt money finance” (OMF) of fiscal deficits, which has long been associated with the curse of hyperinflation, could be a “useful medicine” and “should not be excluded from consideration” by policymakers as they grapple with protracted recessions and feeble growth. “There can be extreme circumstances in which it is an appropriate policy” he said.
Lord Turner, who was an unsuccessful candidate to replace Sir Mervyn King as Bank of England Governor, argued that many economies have been suffering from a collapse of aggregate nominal demand (or spending) since the 2008 financial crisis and that the conventional tools of monetary policy had failed to facilitate durable recoveries. He went on to say that monetary financing of deficits might be needed to restore growth and to bring down unemployment. “We should consider whether there are specific circumstances in which it could play a role and/or needs to pay a role” he said.
Speaking at the Cass Business School in London, Lord Turner rejected the notion that policymakers are powerless in the face of weak growth. ”Governments and central banks together never run out of ammunition to create nominal demand” he said. “Overt permanent money finance can always achieve that and is the only policy lever certain to do so”.
Lord Turner conceded there were “good reasons” to fear that deficit financing could prove inflationary. But he stressed that failing to debate the merits of such a policy was unwise because desperate politicians might otherwise resort to such a policy in an uncontrolled manner. “If we do not debate in advance how we might deploy OMF in extreme circumstances, while maintaining tight disciplines of rules and independent authorities which are required to guard against inflationary risks we will increase the danger that we eventually use this option in an undisciplined and dangerously inflationary fashion” he said.
Lord Turner added that in controlled doses, deficit financing could be beneficial. “Strong disciplines and rules are…essential to ensure that excessive use does not turn [deficit financing] from a useful medicine to a dangerous poison” he said.
Lord Turner, who was appointed chairman of the FSA in September 2008, shortly before the collapse of Lehman Brothers, pointed out that distinguished and diverse economists including John Maynard Keynes, Milton Friedman and Ben Bernanke had, at various times, made the case for central bank financing of government deficits.
Some economists have argued that the problems of the UK economy relate to a lack of capacity to grow, rather than an absence of demand. Lord Turner said that people should be open to the possibility that this diagnosis was true be added that this was an argument against any sort of stimulus at all.