By Scott Jamieson
In its Green Budget paper published last week, the Institute for Fiscal Studies (IFS) offered its assessment of the outlook for the UK economy; it wasn’t pretty. As things currently stand, public sector spending looks set to fall by one third over the 2010-2018 period and public sector employment levels will fall by more than one million. More immediately, government borrowing in fiscal year 2014 is set to balloon by £64bn more than Osborne expects.
So what’s to do? Well presumably sell a load of gilts to balance the budget and hope that things improve. In a detailed lecture, ex-Chairman of the FSA Adair Turner offered another approach: Overt Money Finance (OMF).
The gist of OMF is that, under certain conditions, it is appropriate for governments to finance budget deficits not through borrowing but by simply printing more paper money. Not by stealth (in the manner of quantitative easing) but openly.
In assessing the effectiveness (thus far) of quantitative easing (QE), Turner reminds that the approach relies on the effective transmission of all the cheap money through the banking credit mechanism. As we have seen making money cheap and plentiful to banks and owners of bonds has not resulted in a vibrant economic upswing; rather it has found its way into other financial assets. Under OMF the cash is simply handed directly to tax payers etc; cutting out the ‘middle man’ will ensure that it gets spent. Turner as with many theorists has no doubt that activity can be improved through ‘helicopter drops’ of cash. Not long after the credit crunch the US effectively did this when the Administration announced a one-off tax cut. It was spent, the economy picked up but then, with the windfall gone, demand faltered afresh. OMF has to be perceived to be recurring to be effective.
When comparing QE with OMF it is important to recognise that QE is equivalent to OMF if the central banks eventually decide never to redeem the bonds. However, Turner argues that OMF needn’t lead to a German or Zimbabwe-style hyperinflation. By fine tuning the tax take he believes that the stimulus required will be dimensionally smaller than through QE. Why? The people will spend it. Because of this Turner believes that it needn’t lead to spiralling inflation.
In examining the suitability of OMF currently, he cautiously muses that Japan may be too far gone for OMF to be used safely without creating huge inflation risks. In the US the operation of huge budget deficits financed by – what might eventually be – OMF is proof for Turner that it can work. In Europe he doubts strongly that the political institutions are in place to allow OMF to be applied. His assessment of the UK is interesting: it may be too dangerous because the economy has shown an unhealthy tendency toward higher inflation rather than genuine growth not least because the fabric of industry may be unsuitable for delivering an attractive supply side response to ‘funny money’ fuelled demand born of tax giveaways.
UK economic policy is clearly too tight. If/when it might loosen is a matter of debate; how this might happen just acquired another dimension. Turner may not be at the centre of policy formulation but he has an important voice.
Scott Jamieson is head of multi-asset investing at Kames Capital
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