Should Bank start the helicopter?
Lord Turner said on Thursday the headwinds facing the UK recovery are so serious, the UK authorities might have to throw away the rule book to overcome them, in both bank regulation and the approach to monetary policy.
Robert Peston debates the implications for financial regulation in his latest blog. Given that Lord Turner is one of two leading contenders to succeed Sir Mervyn King, I'm wondering what "still more innovative and unconventional" monetary policies might look like.
The outgoing FSA chief doesn't spell it out in his speech. But in the past, he has talked privately about the possibility of pure money financing of the deficit.
The most well known example of this is the so-called "helicopter drop". For example, the government could simply send every family in the country a one-off "Christmas Bonus" of £1,000, directly financed by money created by the Bank of England.
When a person's "private" comments have been mentioned publicly by so many different people, the word private rather loses its meaning. But it is fair to say that Lord Turner has never publicly proposed this kind of money drop, or suggested that it should happen right away.
Still, as I said on the 10 o'clock news last night, the fact that a man of Lord Turner's position and experience is even hinting at this kind of solution to the UK's problems might be thought to indicate how serious he thinks our position is.
Of course, it also reminds George Osborne that Lord Turner would not be a cautious or placid Bank of England governor. But I suspect he already knew that very well.Manna from heaven?
Radical or not - would a helicopter drop actually work? To even begin to answer this question, we need to understand how this policy would differ from what the Bank of England is already doing, with its quantitative easing.
We find ourselves - as Lord Turner more or less admitted last night - trapped in a nightmare where trying to do the right thing to strengthen banks has the paradoxical and wrong outcome of undermining economic recovery and further debilitating the banks”
After all, on paper, it looks rather similar: the Bank of England is creating money electronically, then using it to buy government bonds or IOUs. Doesn't that amount to the Bank paying for a large chunk of government spending?
Supporters and bank insiders say there is a difference, because the Bank is not simply giving the money to the government. It is lending it, in exchange for a claim on the Treasury in the form of a gilt (government bond) which it buys on the open market more or less like everyone else.
But many economists would say this is not quite the difference it's cracked up to be, not least because both the Bank and the government are all part of the UK public sector (actually, the Bank is technically a private company, but for national accounting purposes it might as well be a public one).
In fact, the difference between quantitative easing and "printing money to fund the deficit" comes down to one thing: when and whether the money is paid back.
That is where the "helicopter drop" proposal comes in.
If you really want to understand all this, you should read David Miles' speech last month to the Scottish Economic Society (NB: If you're scared off by the graphs, just read pages 10-11.)
Since joining the Monetary Policy Committee he has regularly made it his business to explain in his speeches what quantitative easing really is - and try to dispel some of the myths about how it works. The fact that he regularly does this suggests he does not think people understand it yet. He's probably right.
Prof Miles says the easiest way to think about a "helicopter drop" is as a lump sum temporary tax cut - or a one-off reverse poll tax - financed by new government bonds which are purchased by the Bank of England on the secondary market, but with all interest and redemption payments etc transferred back to the Treasury.
This is similar to quantitative easing, to the extent that it is one part of the government lending to and acquiring claims against another. It is also, as Prof Miles notes, similar in that it is reversible. The government could have a one-off tax increase, two years later, to get back the money that has been paid out, just the Bank can now sell back the gilts it has bought under QE.
For Prof Miles, the only real difference between QE and even more "unconventional" money financing is that, with QE, the terms on which the money is created "are flexible and sensitive to inflationary pressures" - whereas in the case of a helicopter drop, the terms are more open.
As long as Bank rate is near zero and the Bank of England buys new gilts to replace the ones that mature, quantitative easing looks an awful lot like a "helicopter drop". But as soon as the Bank starts raising interest rates and selling back those government bonds, the similarity with Zimbabwe starts to disappear.Sky-high prices
For Prof Miles, this raises an obvious question: what, exactly, do we get out of a "helicopter drop" - or the bank just extinguishing all the gilts it has bought - which we do not get out of the policy we have now? For him, it can only be one thing: unwanted inflation.
The point of both QE and more "unconventional" policies is to create more economic activity and prevent deflation, in an environment in which private and public debts are being painfully brought down. Presumably, supporters of money financing would like the policy to be reversed or slowed down if it looks like it is simply creating inflation, with little or no positive impact on real activity.
But if so, that is also what the Bank is planning to do with QE.
In short: "Either money financing... is done in a way which pays no attention to the inflation consequences, in which case it is not a very attractive policy - or it is done in a way which is sensitive to the longer-term inflation consequences, in which case the differences with conventional QE largely evaporate."
Those of you have struggled this far might wonder whether, in an environment of massive private and public debts, a bit more inflation might not be such a bad thing. That is, after all, how a large part of the public debt built up during World War II was brought down.
It is also what many critics believe will ultimately happen as result of the drastic and unconventional tactics that the world's leading central banks have all taken in the past few years.
That is a subject for another day. But I think it would be hard to find anyone who supported a sharp and uncontrollable upsurge in inflation, as a way out of our troubles. Certainly not Lord Turner.
There are those who would like to see the inflation target raised or loosened somewhat. The key point is that this could also happen within the existing framework for QE. It's not clear - to David Miles anyway - that you get any extra benefit from resorting to a helicopter drop.
However, the Miles argument assumes that government borrowing might be the same, in either case. In fact, I think quite a few of those who talk about "pure money financing" of the deficit are really talking about a fiscal stimulus.
Lord Turner may well be right to say that the Bank and the Treasury will have to go further out of their comfort zone to get the economy back on track. But if so, many economists would say focusing all your unconventional attention on how government borrowing is financed misses the point.
For them, the point is not so much whether the money will ultimately paid back - but how and whether it gets through to the real economy.
Put it another way: it depends on how much the government is borrowing, and what it uses the money for. That is also known as fiscal policy. Even if Adair Turner does take over at the Bank of England, I suspect that will continue to be a job for the chancellor.