Why Debt is both Interesting and Important

Yesterday the Resolution Foundations launched a report on Household Debt in the UK. It is, as one would expect of them, excellent. I was on the panel at its launch and had a chance to say a few words. I had prepared bullet points to guide me, and at the suggestion of Tony Yates have typed these into actual sentences, adding also a couple of footnotes and a chart to give a bit more substance to comments that might in retrospect have lacked context. I spoke for nine minutes, and you can actually watch the whole event (including very good presentations by Matt Whittaker, Jan Vlieghe and Sian Williams) here.


Debt is a web of contracts that binds our social and economic lives together. As such, household debt is not only interesting, but important. Its importance can be seen at a very human level, and bodies like Toynbee Hall do great work in ensuring that the profile of this very human aspect to debt is rightly prominent. But it is important also to our understanding of the macroeconomy, the stability of the financial system, and our understanding of the nature of monetary policy.

Discussing household debt is a strange thing to do at an aggregate level. By this I mean that it makes absolutely no sense to think about it as if it was attached to a representative household. Evenly distributed in a closed economy, no level of debt is unsustainable or unserviceable. But, evenly distributed, debt is also functionless.*

Another complication in thinking about household debt from a representative household perspective is that – unlike a household – changes in savings rates and gross debt, while individually important for activity, are entirely unrelated at an aggregate level.** Instead, Household debt appears to be largely a distributional issue for the household sector – intermediated by the financial sector.

However, changes to household debt have a variety of important macroeconomic and policy, as well as human, implications.

Starting first with the economy, it is pretty straightforward that changes in household debt are important to demand. Given the relatively self-contained nature of household debt, rising debt looks – from an empirical perspective – like a transfer from households with a low marginal propensity to consume (MPC) to households with a high MPC. The chart below the level of monetary assets and monetary liabilities residing in the household sector over the last twenty years. When the blue dots are above the orange line, the UK household sector has net monetary liabilities that exceed net monetary assets. To be clear, this does not include non-monetary assets like housing, equity, land, and other stuff. It’s just monetary or pseudo-monetary assets.*** An observation one might make is that monetary assets and liabilities are around the same level as one another, and so while the reality will be messier, we might think of household debt as being on a net basis an intra-sector distributional issue.

Household monetary assets vs household monetary liabilities, 1997-2016

When a rise in aggregate consumer demand has been accompanied by a rise in household debt we can and should ask to what extent such a move upward in debt load might be sustainable. Having a sense as to how this debt growth has been distributed amongst different debtors, what form this debt takes, and how vulnerable the debt service is to changing short term interest rates is helpful – and the report helps us understand better these things.

Secondly, changes and levels in household debt have important implications for financial system integrity. One person’s debt is another person’s asset, and as such, a precarious debt load is not an issue only for the indebted, but for the owners of capital. The relatively self-contained nature of household debt, intermediated by the financial system, means that higher debt loads lead to more counterparty risk. And this counterparty risk is likely to concentrate in financial institutions.

Indeed, many of the recent financial crises and recessions have been characterised by a series of debt contracts that we have ‘known’ as having low-credit risk characteristics suddenly being revealed as having high credit-risk characteristics (the Eurozone sovereign debt crisis, structured credit during the Global Financial Crisis, the dotcom/ Anderson credit bust, and the Savings and Loan Crisis to name but a few). As Mark Twain put it with somewhat greater panache: ‘What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so’. The Resolution Foundation report and much of the work that the Bank has done on UK household debt points to there being no great threat today, and from what I see I would agree. Whether this take is wrong will be a matter of record.

Thirdly, changes to household debt can tell us something about the appropriate stance for monetary policymakers (in ways only tangentially related to point one). Claudio Borio of the BIS outlined the issue nicely in a 2013 paper when he asked whether, in seeking to understand whether an economy is operating beyond trend, monetary policymakers should consider both inflation and the growth in private sector credit as signs that the economy was operating above potential growth. Jan Vlieghe in his speech to the SBE conference in 2017 argued that information about the location of the equilibrium rate of interest might be embedded in directional changes in household debt load. But changes in financial depth and the arrival of things like PCP finance that might just be a step change in the way we purchase things – that the report highlights as accounting for much of the UK consumer credit growth in the past couple of years – might be important to consider as part of these frameworks.

So in summary, this report’s analysis is really welcome. It helps us to better understand the changes in household debt and lifts the bonnet on important distributional issues. I agree with its findings that household debt does not look – today – to represent a threat to financial market stability and it makes a strong case that the credit surge does not appear to be associated with a dangerous over-extension among families least able to bear higher debt loads sustainably. And it highlights the pinch points for the future, which as one might have guessed sit with the more financially fragile households.

However, I wonder to what extent the transmission mechanism of monetary is to effect transfers from those households with high MPCs to those with low MPCs, crushing demand from indebted households – as suggested by James Cloyne et al in their 2016 Working Paper (although admittedly they said that this aspect was swamped by general equilibrium impacts of rate changes). Will an enhanced understanding as to the real human cost of rising rates change policymaker reaction functions?



Pesky footnotes: probably the most interesting bit of the blog.
* If you and I each create an IOU due in two years time for £1 trillion and hand them to one another, both assets and debts are created. The magnitude of this act of asset and debt creation us such that UK household debt would – in aggregate – more than double. But because we each held the means to service our enormous individual debts (in the form of our enormous individual assets, which consist of claims on each other), the debt is utterly serviceable and sustainable. It is also functionless.

Really interestingly, Chakraborty et al put out an amazing paper algo-guessing a complete loan-level data set in December last year. I really recommend people read it here

** I didn’t understand this for the first twenty years of my career. I tend to think of savings as claims on others (eg, monetary assets). But, using the logic of the ONS Blue Book:

The household savings ratio is equal to the net change in claims on other sectors [i.e. change in household net lending/ borrowing number (NSSZ)] plus the cost of building new homes [ok, it’s actually the total gross capital formation number (NSSX), but that’s basically the same thing], plus a tiny number that hardly registers [aka, the acquisition less disposals of non-produced non-financial assets (NSSY)], all divided by total household resources (NSSF). To be more specific, it is these codes but particular to the household sector rather than the household + NPISH sector, but I don’t have them to hand, and they are pretty much the same numbers.

Household debt is the sum of all of the debt liabilities of households.

So – and quite logically – if Bank X creates a deposit through lending £20 to Household X, so that Household X can buy a service (let’s say a haircut) from Household Y (who then saves it), total debt rises by £20, but there is no change in the household savings ratio. There has been an expansion of the total household balance sheet, and an intra-household-sector change in the distribution of monetary assets and liabilities.

*** Household monetary assets are defined here households’ holdings of money, debt securities, and other accounts payable, plus non-life insurance technical reserves; household monetary liabilities consist of loans and accounts payable.


Household Debt in the UK

Yesterday I argued that if you want to discuss what changes to household debt might mean, you need a decent framework for assessing the fluidity of the microstructure of debt. To illustrate I set out two hypothetical countries with identically modest aggregate household debt loads – but with different sensitivities to changes in interest rates, and differing levels of financial stability. I called them Debtzania (where debt is concentrated and debt-to-income ratios for debtor was high) and Feudaland (where debt is thinly spread and a few households are creditors).

Which of these economies does the UK most resemble?

Using the NMG/ Bank of England survey data we can examine where it is in the income distribution that UK household debt falls.

Table 2 shows that most debt is owed by those in the top three deciles of the income distribution, and on sums below £175k. The mortgage-dominated nature of this debt and the untroubling LTVs with which it is associated may explain it to some as both rational and desired.

Table 2: Where household debt sits, by pre-tax income decile and total debt cohort

We can perform the same analysis for deposit balances held among our sample (knowing that at the macro level, total monetary assets and total monetary liabilities in the household sector are roughly the same), the output of which is shown in Table 3. It is perhaps not surprising that most of the money is owned by members of the upper half of the income distribution.

Table 3: Where household deposits sit, by pre-tax income decile and total deposit cohort

We could treat each income decile as a separate sector and look at the transfer of net monetary claims between them (in the form of savings and borrowings). This is shown in Table 4, and the data suggests that the flow of savings is on a net basis from lower income cohorts to upper income cohorts, typically to deliver mid-sized mortgages (we could, of course, reverse the causality in this description). This concentration of debtors might sound a bit more Debtzanian than Feudalish.

Table 4: UK households by pre-tax income decile and total debt cohort, estimated net saving/ borrowing flow

But debt sustainability is only really an issue for those in debt, and will correspond to their ability to service debt. And so in Table 5 we examine how debt-to-income ratios vary across the our matrix of UK household debt and income distribution. After all, small cohorts of high debt-to-income ratios was the thing identified as problematic when looking at otherwise untroubling Debtzanian aggregate debt statistics. Here we can see that debt-to-income ratios look pretty high for almost all debtors, but least troubling for highest income households where most nominal debt resides.

Table 5: UK household debt-to-income ratios, by pre-tax income decile and total debt cohort

And so the problems for policymakers seeking some rules of thumb to estimate sustainable or unsustainable levels of household debt appear twofold.

First, there is a data issue. Our sample size of around 6,000 households is small (as evidenced by @jmackin2’s outrage yesterday), even before we start to exclude households that refuse to give data in which we have interest. For the purpose of this blog I have used a snapshot, but I think that we need to compare datasets on a longitudinal basis. When the numbers on the matrix change, we need to understand whether this the result of movement on the income dimension or debt dimension.

Second, we have a question over the appropriate unit of analysis. In discussing Feudaland and Debtzania we argue against this being the overall economy, but as suggested by a comparison between the matrices of debt and income distribution on the one hand, and deposits and income distribution on the other, splitting the population into income deciles takes us not much closer to the issue at hand. There are meaningful flows between debtors and creditors within members of any given income decile. The appropriate unit of analysis is perhaps the household. But that statement seems a bit nuts.

The chart below looks at individual households in the NMG survey, rather than treating them as aggregated cohorts. It’s messy, but maybe messy is what works.

Putting aside human concerns for families struggling with the very real problems attached to sever indebtedness, why should policymakers care?

FPC members care because widespread unsustainable household debt can lead to problems for financial stability. But, through this lens, problems in debt service among low income households with small but unsustainable debt balances are just not worthy of deep interest: they are insufficiently likely to cause systemic financial problems.

MPC members care because changes in appetite for debt might tell them something about the location of the neutral real interest rate. Through this lens it might seem that it doesn’t matter what individual households are doing, but does matter what they collectively do. And I guess that if this is true, changes in the optimal level of debt which can only be inferred from an examination of its microstructure will be an important in any decision as to the wisdom of ‘leaning against the wind’. And they will care because cashflow impacts for indebted households following changes in interest rates are part of the transmission mechanism.

What to do?

Despite data shortcomings, there are some suggestions that we can draw out. First, in considering changes to household debt, policymakers should do well to treat aggregate debt statistics with caution. Having an idea as to whether they are dealing with Feudaland or Debtzania, and the degree to which there is stability in the microstructure of the debt distribution seems important. Second, examining the entire distribution of nominal debt-weighted debt-to-income ratios (and changes thereof) appears to be a step towards more capturing more meaningful household debt characteristics, changes in household behaviour and systemic debt problems.

Reverse ferret on household debt

A couple of blogs ago I posed the question as to how the sustainable level of household debt might be identified for an economy. I then reckoned that there might be a decent 30k ft way of addressing this question. This post serves as a bit of a reverse ferret. I’m not saying that the previous approach was wrong, but after some back-to-basics thinking I understand that its rightness is overly-dependent upon the stability of something that it may or may not be wise to assume. In my defence, I reckon *every* macro approach relies on this stability (comments section please to correct me). But I take little comfort in expressing a popular view based solely on its popularity.

Debt is an entirely distributional issue. Evenly distributed in a closed economy, no level of household debt is unserviceable or unsustainable. But evenly distributed, debt is also functionless. Every sustainability question rests upon the microstructure of debt loads across different households. And so, from a macro perspective, debt is tricksy to say the least.

This all becomes clear in an example. Let’s imagine two super-simple closed economies with no sectoral flows: the Kingdom of Feudaland and the Republic of Debtzania.

The Kingdom of Feudaland consists of 10m households, each of them with perfect equality of employment income (at £20k per annum), making its GDP worth £200bn per annum. Household debt sums to £20bn, and interest rates are 15%. Debt is owed by 9.625m households to the other 375,000 remaining households (evenly). Interest costs are eminently serviceable (£312 per annum per household in transfers from the debtors to the creditor households, each of whom receives a handsome £8,000 per annum in interest).

The Republic of Debtzania also consists of 10m households, each of them with perfect equality of employment income (at £20k per annum), making the GDP worth £200bn per annum. Household debt also sums to £20bn, and interest rates are also 15%. Debt is owed by 375,000 households to the other 9.625m households (evenly). Servicing this debt costs the debtor households £8,000 per annum. The creditor households each receive a modest £312 in interest income on their savings.

Table 1: Feudaland and Debtzanian debtmetrics

The aggregate debtmetrics for Feudaland and Debtzania are exactly the same (Table 1). At 10%, the aggregate household debt to income ratio looks pretty low, as do aggregate interest payments as a proportion of GDP at 1.5%. But the microstructure of the debt distribution is what matters in assessing the sustainability or otherwise of these two economy’s debt loads.

Feudaland, despite its wealth inequality, looks to be a beacon of financial stability. The debt-to-income ratios for debtors are pretty low at 10.4% of income, and servicing ongoing interest costs is universally manageable, absorbing 1.6% of income. Feudaland’s wealth inequality might eventually prove politically unsustainable, but it would be hard to call it financially unsustainable, even in an environment where interest rates doubled.

Despite exactly the same aggregate debt-metrics, Debtzania looks much more financially fragile than Feudaland. The majority of its citizens are savers, but they have amassed claims on the small minority of financially-fragile debtors who must pay out 40% of their incomes in interest payments to keep out of default. Debtzania debtors’ debt-to-income ratios are individually high at 267%, and it is probably fair to say that a doubling of interest rates might bring meaningful problems to Debtzania’s financial system (with associated morality stories).

Now imagine being a monetary policy maker in each of the two countries. At what point should you worry about changes to aggregate household debt, and at what point could you infer that household debt in your country is too high? If a policymaker looked to their countries’ respective histories for clues they would, in so doing, be making the assumption that the microstructure of debtor-creditor relationships would be relatively static (or at least semi-stable) over time.

With a static microstructure of debt in Feudaland we might expect to see household default rates relatively unresponsive to wild changes in aggregate debt loads or interest rates. Policy makers might draw the lesson that household debt – at only 10% of GDP – is far too low to worry about, and that rising debt could be a sign that households were moving towards their optimal debt load (and so should not be met by any ‘leaning against the wind’). One could even imagine the cultural trope of creditworthiness being assigned to Feudalanders (backed by the empirical evidence of minuscule historical credit losses).

With a static microstructure of debt in Debtzania, we might by contrast expect to see household defaults rise and fall with both real (and nominal) interest rates and debt-loads. Those 375k households who do the borrowing may – if cross-country evidence holds in our mythical land – do a disproportionate amount of the spending in the economy. And so monetary policy might prove a particularly speedy macro tool for demand management: introducing higher and lower pain thresholds to debtor households and transferring higher or lower amounts of debtor household incomes to creditor households with lower marginal propensities to spend. It would be unsurprising if Debtzanians acquired a reputation of being quick to default; concerned politicians might encourage them all to save more.

In short, if the structure of the distribution of debt was utterly unchanging in both countries, policymakers might reasonably rely on each country’s individual history of debtmetrics to determine policy pinch-points.

But the usefulness of any historical comparisons (in terms of aggregate debt-to-income ratios or debt-service ratios) rests on this microstructure of debt being pretty concrete. The more changeable the microstructure, the less useful any historical comparisons.

Imagine again that the microstructure of debt distribution in Feudaland shifted to match the distribution in Debtzania, perhaps as its demography shifted through population ageing and associated changes in savings habits. A policymaker following only aggregate debtmetrics might infer that the change in default patterns was associated with some cultural shift in the population. When in fact, aggregate debtmetrics had instead done a good job at masking this demographic sea change.

It is not clear that I, or anyone else who makes macro comments on matters of household debt, has a decent framework for assessing the fluidity of this microstructure.

In the next post I look at the data that I can see readily available for the UK.

Finding the *right* level of household debt

My last post reflected on the Borio/ Vlieghe idea that the Equilibrium Real Rates (ERR) should perhaps be defined not just by inflation, but also by changing debt levels. Since then I have been thinking about that list of tricksy questions I listed at the end of the post. I want to have a stab at one – specifically, whether it is possible to define the ‘optimal nonfinancial debt’ for an economy. Short answer: maybe, but I don’t have the skills to know*; in the meantime I’ve got a way to think about it from 30k feet. 

Thinking about optimal debt loads from 30k feet by cleverer people than me has had a frankly shocking record.** That said, my MPhil thesis on the geopolitics of emerging market finance, has given me familiarity with debt sustainability models that I think could maybe be helpful. The bottom line of debt sustainability frameworks tends to be that there is rarely an impossible level of debt, but debt does get meaningfully tougher to service as debt rises, rates rise, and growth slows. Big surprise.

Let’s look at the UK household sector as a whole through the lens of a super-simplified sovereign debt dynamics framework.*** We know what disposable household income growth and effective interest rates have recently been. And we know where the household debt stock has got to. As the chart below shows, it has risen to 138% of disposable income.

So what is the ‘primary surplus’ (or in the households’ case the net acquisition of financial liabilities minus interest payments as a percentage of household disposable income) required to stabilise household debt-to-disposable-income at 138%? The answer is around about 2% right now. And what is the actual ‘primary surplus’? Around -2%. So debt is growing, and is growing quickly. And the Bank of England appears to be worried about this worrying rise in household debt. (Again, read the last blog on this here.)

We can compare the primary surplus required to stabilise debt levels over time (blue line in the chart below) to the actual primary surplus recorded by households (grey line). You may notice that when the grey line is below the blue line, debt rises. When the grey line is above the blue line, debt falls. It’s a super-simplified little framework. The chart on the right compares the gap between the two lines to the change in debt-to-income: we can see that it doesn’t capture everything, but it sort of works(ish).

While extremely simple, this framework highlights the degree to which the issue of changes in debt sustainability (a somewhat different and easier question to the optimal debt load question) is a function of income growth, interest rates and debt loads. And in seeking to answer the question as to why households have re-levered recently, we can quickly hypothesise an answer that doesn’t involve a spending splurge. (The incredibly smart Neville Hill at Credit Suisse, who kindly shared his data with me that I used to calculate the blue line, argues exactly that here.)

What pushes the blue line up and down so erratically? Well, the most volatile input to the little debt dynamics ‘model’ is household income growth. The spike up in the blue line in recent quarters appears to have been driven by a collapse in nominal household income growth through 2016. In other words, it sort of looks like households are expecting the sharp recent slowdown in income growth to be temporary.

If the slowdown in household income growth isn’t temporary and the Bank of England raise rates to try to control household debt growth, the blue line gets a double-whammy. The following projection shows the path of the breakeven primary surplus in an environment where household disposable income growth continues at the sluggish pace of the last year and three rate rises over the next three quarters:

Actual household consumption would have to drop consumption pretty darn quickly to stabilise debt levels. And I can see households interpreting this as monetary policymakers arguing that the beatings will continue until morale improves.

Where does this leave the idea that an understanding of the ERR should take into account debt growth? I’m still scratching my head on this, but it seems to introduce some qualifications at the least.

* Given the importance of this question for all sorts of things, it is frankly weird that there hasn’t been more research on it. I feel pretty confident that it might be advanced by some awesome econometricians who have experience in mining large panels of ONS household data, but is there anything to say on the matter before then?

** In the wake of the GFC, Ken Rogoff and Carmen Reinhart’s empirical work on debt at a sovereign level attracted sufficient policymaker attention to get them cited as the intellectual handmaidens of austerity. Indeed, ex-UK Chancellor George Osborne cited their work directly ahead of the fact as the rationale supporting austerity. But since the aspects of the R&R work looking for debt optimality has been shown to be uncharacteristically error-strewn.

*** Simply d[(r-g)/(1+g)]=pb, where d = debt/ disposable income; r = effective household interest rate; g = annual growth in household disposable income, and; pb = household net acquisition of financial liabilities minus interest payments as a percentage of household disposable income.

Tl;dr for the TSC

A few months back the UK Parliament’s Treasury Select Committee (TSC) invited anyone and everyone to submit in 3,000 words their views about post-crisis monetary policy. I can imagine that TSC members’ junior researchers must have been thrilled by the prospect of reading all the submissions for their political masters on the 16 open-ended essay questions set in the terms of reference.

I read all thirty four of the written submissions and post the tl;dr for each below so you wouldn’t have to. Thirty four. I hope that the authors who see each of their 3,000+ word missives so ruthlessly and flippantly précised (with potential misreading) take this in the good spirit in which it is done.

Why did I do this? Erm… It seemed like a better idea at the start than it did by the end?

Actually, three reasons. First, political support for Bank operational independence has been sagging. The Prime Minister has been drawing attention to distributional inequitiesassociated with QE. The Chancellor had to make a statement to Parliament in support of QE after City rumours of private briefings in which he inferred that backing for further rounds of QE would no longer be forthcoming. Senior Conservative politicians have publicly attacked the Bank (for example, here or here). And the Labour front bench have been airing prospective reforms that would remove operational independence. It was in this political context that the TSC, which holds the Bank to account, launched its inquiry into post-2008 monetary policy. I wanted to get a sense as to what the submissions said.

Second, I read a lot of policymakers, academics and investment bank stuff about QE. Much of it is very good. But this is a genuine free for all from bloggers, academics, finance professionals, think tanks, former policymakers and private unaffiliated individuals who could be bothered to express a view. I found in the submissions some perspectives that were genuinely new and interesting to me. Reading them has sparked a bunch of thoughts.

Third, I submitted myself, and so was interested as to where my views sat within the body of submissions.

I also learned during the course of reading these about the Cobden Centre, which appears to have done a decent job of making its presence felt rather firmly. The Centre which appears to campaign for an end to fiat money was founded by Steve Baker MP, a member of the TSC, who used to work in IT at Lehman Brothers before turning to politics. Affiliates of the Centre submitted five of the thirty four written testimonies and gave one of the three oral testimonies. I have no sense as to whether these submissions were coordinated or not, but thought it striking that only one of the five written submissions mentioned their affiliation in their self-description.  Four of these written submissions can probably be summed up with the words ‘buy gold’; the fifth was fascinating. I have put these together at the end.

The summaries are in the order shown on the Parliamentary website, but grouped into policymakers, academics, finance folk, think tank, unaffiliated, and Cobden; I include Twitter handle where I could find it. They start long and get shorter…


Current and former MPC members

Ben Broadbent, Deputy Governor Monetary Policy, Bank of England

Monetary policy can affect nominal quantities, but not real ones over the long term. Real bond yields are set globally, diverging due to local risk premia or the market’s currency expectations. As a small open economy, our real rates are imported and low policy rates are a symptom, not a cause. Target saving can’t be a thing if savings rate falling. QE works. DB pension deficit not our fault, but probably haven’t hit growth much. Precautionary hiking to lean against the wind of financial imbalances appropriate only if macropru unavailable; BoE has FPC. Distributional impact analysis shouldn’t leave out impact of looser policy on overall income of both savers and borrowers (Cloyne 2016). Low productivity leads to low rates, not vice-versa. When QE is unwound BoE balance sheet will, nevertheless, need to be pretty big given regulations and banks’ demands for reserves.

Professor David Miles, ex-MPC member

Like @moyeenislam, reckons post-QE will still see huge reserve balances for banks, but QE need for duration will be absent. So BoE should own UKTBs to limit capital risk.*

*But he knows there aren’t enough T-Bills and so is flagging that the UK government needs to change its debt profile and shift it much shorter as QE unwinds. It could also be interpreted as an area for monetary-fiscal collaboration that saw the BoE signal that it will be a steady holder of short-term financing instruments for HMT and so HMT can benefit from lower debt service costs (if term premia proves to be positive).

Andrew Sentance, PWC and former member of the MPC (October 2006 – May 2011) @asentance

Rate cuts and QE were appropriate responses to crisis but ushered in generally above-target inflation but not stronger growth. Much of the time the BoE was ‘looking through’ ‘one-offs’, but this looks a little silly over a decade. Adverse consequences from post-08 monetary policy felt in housing (boosting prices), pensions (elevating deficits), savings (incentivising people to spend or buy risky assets) and productivity (zombies and service sector getting trade boost from GBP weakness that made it unnecessary to invest). Hike rates.

There is also an oral testimony that you can watch here from Charlie Bean and David Miles,as well as Detlev Schlichter – a guy from (you guessed it) the Cobden Centre.



Professor Huw Dixon, Cardiff Business School @Econdixon

Policy of financial repression is being pursued and is mistaken given economic output and employment are around ‘natural’ levels, hurting savers and retail banks and helps hedge funds and investment banks. Inequality a problem but not one for monetary policymakers. Hiking rates to 3-4% will boost confidence. Doesn’t seem to understand basic monetary economics double-entry book-keeping.

Professor Emeritus Sheila Dow, University of Stirling, and former special advisor on monetary policy to the Treasury Select Committee (2001-10) @sheilacdow

Distributional effects of monetary policy changes should be analysed ex ante as they impact effectiveness of policy transmission. Also, in concerning itself with aggregates rather than distribution, a value judgement is made that market processes ensure a just distributional outcome (wages and salaries reflect worth, etc). Distributional impact of monetary policy can create social problems that require fiscal spend to fix. Bank-HMT cmte should form to discuss interdependencies.

Professor Richard A. Werner, D.Phil. (Oxon), Chair in International Banking, University of Southampton who invented the term Quantitative Easing as a recommended policy for Japan in 1995 @ProfessorWerner

Interest rates are not a useful tool of monetary policy but should rise. BoE should desist QE, try to steepen the curve, and pressure UK banks to lend to non-financial SMEs. Bank credit creation determines nominal GDP growth. HMT should stop issuing bonds and borrow from banks.

Isaac T. Tabner, PhD, CFA, DipPFs, Senior Lecturer in Finance, University of Stirling Management School @IsaacTabner

Lower interest rates make house prices rise, absent generalised deflation.

Roger E. A. Farmer, Research Director for Macroeconomics, NIESR @farmerrf

There is no NAIRU or natural rate of interest. If inflation doesn’t rise, BoE should hike rates while either HMT does coordinated fiscal easing or BoE buys lots of equities. FPC can and should maintain a price for the average value of publicly traded equities that is consistent with full employment.

Lord Skidelsky, cross-bencher and Keynes biographer @RSkidelsky

Near-ZIRP & QE have probably helped at the margin but the distributional impact has been counterproductive and adverse, threatening independence. Fiscal is better. British Investment Bank. People’s QE.

Tony Yates, Professor of Economics, University of Birmingham @T0nyyates

QE was necessary (although not flawlessly executed); Forward Guidance was pants; inflation target should be raised to 4%; MPC should declare expected rate path; and an institutional architecture should be prepared for large-scale private asset market intervention, technocratic fiscal coordination, and introduction of helicopter money.

Professor Philip Haynes, University of Brighton @profpdh

QE boosted asset prices, including house prices. Rents too. And wealth inequality. Monetary policy should target credit at productive investment, working with the Chancellor.

Professor Mariana Mazzucato @MazzucatoM and research fellow Matteo Deleidi, University of London

Lower rates boost household demand for housing and goods, pushing debt higher; corporates investment intentions don’t respond to changing price of debt. Fiscal expansion would’ve been better than QE.

Eric J. Levin, Reader in Economics (Retired), University of Stirling and Robert E. Wright, Professor of Economics, University of Strathclyde

Viscous loop in play: demographics forcing up savings rates, pushing down demand and interest rates, wrecking pensions funding and boosting demand for bonds.

Professor Francis Breedon, Queen Mary’s University of London

QE could have been £2bn cheaper if executed via HMT issuing directly to BEAPFF (although this would have been illegal under Art 123 of Lisbon Treaty).


Finance folk

Association of British Insurers (although written by NIESR) @BritishInsurers

QE has increased DB pension deficits and lowered annuity rates. Under Solvency II, lower interest rates increase both the value of liabilities and the quantity of capital that insurers need to hold to insure their non-market risk, creating a trade-off between the fund’s valuation and its solvency. The highly sensitive nature of these movements to interest rates can generate volatility, which is a challenge to manage, dis-incentivises the insuring of longevity risk, and acts pro-cyclically. 50bp rate change moves Risk Margin by 20%.

Robin Churchouse (Finance Director) and Andrew McPhillips (Chief Economist), Yorkshire Building Society @Yorkshire_BS

Savers hit by QE, and markets have grown dependent on central bank support. Target saving not really observed, but nor have low rates reduced saving. Distribution is a matter for HMT.

Professor Mark Blyth, Brown University, @MkBlyth and Eric Lonergan, fund manager at M&G @ericlonners

QE1 was good, less so later versions. Success of policy 1980-2008 maybe dependent on coming from starting position of anachronistically high real rates. Monetary policy largely out of road; heli-money to households is the way the BoE should best respond to a downturn, should it come before rates are high enough to be cut in response.

Toby Nangle, Global Co-Head of Multi Asset, Columbia Threadneedle Investments @toby_n

Target saving a thing, but jury out on how big. QE sorta worked by boosting asset prices but houses are assets too. Death of DB pension system accelerated by QE, but regs and global environment too; low rates an opportunity for HMT. Nangle-Goodhart. Awesome charts.

Building Societies Association @BSABuildingSocs

QE was necessary, but further rate cuts, and in particular negative rates, could be counterproductive. Target savers abound, their number boosted by rising house prices and falling rates. Brexit will hit investment and economic growth.

Peter Dixon, senior economist at Commerzbank AG @commerzbank

Monetary policy is overburdened in the UK but the BoE has done a decent job. Target saving is a thing.

Neil Smith, Altus Investments & Plymouth University @NelsonSmythe

QE is bad unless it’s People’s QE. Abba Lerner was right and the UK should embrace Functional Finance.


Think tanks

Tomorrow’s Company, think tank @Tomorrows_co

QE sort of worked by boosting asset prices and household wealth (unsustainably), but a shame it was needed. Sectoral flows approach taken and monetary toolbox empty, absent overt monetary financing. Companies never reduced their hurdle rates so diminished monetary transmission. BoE chat kept GBP firm, undermining international rebalancing.

Positive Money, think tank @PositiveMoneyUK

Banks don’t really lend to businesses any more so low rates & QE just boosts asset prices (incl housing) and heighten inequality, especially between generations. People’s QE.

New Economics Foundation, think tank @NEF

Loans make deposits. QE1 stopped a liquidity crunch but made the rich richer. Bank lending overwhelmingly secured on property so property cycle key. BoE should target inflation, finl stability, inequality, house price inflation and employment at a regional level, public and trade deficits and ecological considerations. And a pony.

Jubilee Centre, a Christian think tank @JubileeCentre

The system is broken. Move to 100% reserve-based banking, complete household deleveraging, and abolish LOLR as well as tax breaks associated with incurring debt.

pH report

The UK population is ageing. We can prove it. Also, monetary policy isn’t set up to deal with this.



Michael R Garrard, a straight-talking autodidact

This man has been successively ripped off, is rightly pissed off, and is articulate. Reckons MPC is not in control: private companies are.

Richard Simmons studied as an economist and has worked in businesses

QE should fund big venture capital funds that can equity-finance early, mid, late-stage projects or infrastructure, with spin-out privatisations profiting the state.

Ralph Musgrave, economics blogger and unsuccessful British National Party PPC in the 2010 General Election @RalphMus

Today’s regime is a dog’s dinner! People’s QE.


Cobden Centre @CobdenCentre

I thought it best to group all the affiliates of the Cobden Centre together (where affiliates are defined as people described by the Cobden Centre on their website as their authors, founding fellows, directors etc). The Cobden Centre campaigns for an end to fiat money and was co-founded by Steve Baker MP who sits on the TSC.

Toby Baxendale, former vendor of wet fish and co-founder of The Cobden Centre @TobyBaxendale; Max Rangeley, founder of ReboundTAG @NotesfromMax

QE is immoral; shift to 100% reserve banking and a low tax regime should happen. The global liberal elite should be worried. Things will end badly.

Alasdair Macleod, Head of Research at Goldmoney @MacleodFinance

Buy gold. We need a policy of sound money to build solid foundations for economic growth, and a gold standard works deliver sound money. Buy gold.

Vishal Wilde, student who ‘devote[s] his life to fighting for Freedom and Justice because he believes God’s Will is a Free and Just Will’ and has written for the Adam Smith Institute

Multiple monies in circulation and free banking would be great.

Keith Weiner, founder of the Gold Standard Institute USA @kweiner01

Whatever the question, gold is the answer.

Anthony J. Evans, ESCP Europe Business School and IEA @anthonyjevans

BoE should target nominal income rather than inflation. Policy is too loose and has generated malinvestment. Markets provide better answers than policymakers. Some nice framing of epistemological questions.



Printing clever weird stuff … aka money

The ECB is warming up to engage in quantitative easing this quarter. Again the newspapers will be filled with stories of money printing. And so it seems an opportune time to again ask ‘what do we mean by money printing?’

The phrase appears pretty self-explanatory, but kind of assumes that we know what money is. But we all do know what money is, right? It is possible that I was late this. So I thought it might be worth skimming through some basics with respect to what money actually might be in case anyone else has become a bit confused along the way. Then a bit on what money printing is. I apologise in advance.

First of all, there is not just one sort of money, but two: Inside Money and Outside Money. The distinction is not trivial.

Inside Money is private sector money endogenous to the financial system; it constitutes the vast majority of what we tend to think of as money (c£1.7tn in the UK if we exclude things that probably need to be excluded), but is more handily remembered as ‘stuff’ that is kept inside banks, and can never ever ever leave them. This is because Inside Money is short-term tradable bank debt (often also known as a bank deposit) effectively sitting on a series of giant interconnected spreadsheets. Put another way, most of what people understand as their own money is just a massive series of interconnected spreadsheets. People will give you real-life things in exchange for you instructing your bank to reduce the number in your spreadsheet cell and increase the number in your counterpart’s spreadsheet cell, but it would be a bit silly to think you could take the actual numbers out of the spreadsheet.

Outside Money on the other hand is stuff that looks like stuff we tend to refer to as money: banknotes with physical form, (but also bank reserves, more on which later). Outside Money is more handily remembered as stuff that can exist outside of banks although most of this stuff still only exists on spreadsheets. How much Outside Money is there in the UK? There are about £70bn notes (and coins), and another £300bn in reserves (spreadsheet Outside Money that only banks can own) in the last weekly Bank of England return (although there are a few other things on the balance sheet that might also qualify, taking the total up to maybe c£400bn).

The trick that any functioning banking system needs to pull off is to make these two sorts of money appear utterly interchangeable (when in fact they are oil and water). Or as Ha-Joon Chang pithily puts it ‘banking is a confidence trick (of a sort), but a socially useful one (if managed well)’. I agree.

What sort of money is being printed when central banks quantitatively ease? Outside Money. Outside Money is the liability of a Central Bank (and HM Treasury), that is to say, like Inside Money, it’s a sort of debt. Crucially, it is a liability of a State that is short-term rather than long-term. It’s short-termness defines its moneyness. What do I mean by short-term? An overnight deposit would be short-term obligation of the State. A ten-year government bond on the other hand would be a long-term obligation of the State.  (The weird thing about the short-term obligations is that they are repayable only in themselves. But don’t get too hung up on this quite yet.)

In fact money, whether Inside or Outside, will always be someone’s debt. If you have deposits at a bank, you are on the creditor of the bank. If you have notes and coins in your pocket you are a creditor of the State. As long as not everyone tries this together your bank should be able to redeem its debt to you (ie, pay you back the Inside Money that you have on deposit in the form of Outside Money) without notice. But in a fiat money world, the state never needs to pay you out. This might make Outside Money sound like a bad deal (forgetting for a moment that Inside Money is in some ways just a sort of ersatz Outside Money).

So what is Outside Money actually good for?

  1. The quick answer is paying taxes. Having a heavily-armed State threatening to exercise its monopoly use of violence against you to extract payment in a currency of its choosing concentrates the mind. Taxes are debts that are invented by the State in a manner that its controllers see fit (the People, the political classes, the Autocrat, whoever). They can be progressive or regressive, life-enhancing or otherwise. But by projecting debt unto the people, the State projects a widespread and regular demand for its Outside Money into an economy.
  2. The long answer is society.

I think that this is pretty amazing.

Secondly, how do Central Banks print this money?

In straightforward quantitative easing (as opposed to quantitative and qualitative easing as seen in Japan) they buy government bonds from people/ firms/ agents. In so doing they take a long-term tradable debt security (aka a bond) out of the market, exchanging it for bank reserves (a Central Bank deposit of sorts). (NB, if financial intermediaries are using these bonds as collateral – that is to say in money-like ways – things possibly get complicated.)

And given that money is always a debt (and it is), we can see that by engaging in quantitative easing, a Central Bank exchanges one State debt (a long term government bond) for another (bank reserves) without actually increasing or decreasing the total debt of the State. What has occurred? The maturity of the State’s debt has been changed.

So money-printing doesn’t change the amount of State liabilities out there, it just shortens their maturity profile. Does this create refinancing risk? I would argue not, given that Outside Money is at once short-term (eg an overnight Central Bank deposit rather than a 10 year government bond) and perpetual (eg unredeemable in anything other than itself). Outside Money is clever weird stuff.

Finally, in saying that QE ‘just’ changes the maturity profile of government liabilities I am not intending to diminish it. Unlike private debt (issued by non-financials to fund expenditure within a household budget constraint), monetary sovereigns issue debt to monetarily sterilise their fiscal expenditures. That is to say that they sell government debt not because they need the money to finance government expenditure but because they don’t want quite so much Outside Money with which they have paid civil servants, government contractors, benefit recipients etc, sloshing around the system, and so they effectively mop it up by selling government bonds. Government bonds cannot be used in quite the way that overnight Outside Money can be (again, assuming that they aren’t used as collateral.) And so quantitative easing represents the desterilisation of past fiscal deficits – no more no less. But perhaps that’s for another day.


PS: Yes, I know that all the above is only questionably applicable to the ECB given that there is an ambiguity over what Inside Money is and what Outside Money is in the Eurozone. This rolling ambiguity is actually an essential characteristic of the Eurozone monetary crisis.

Why is the Debt Management Office no longer part of the Bank of England?

Click-bait of a title, I know. 10.25pm on a Sunday night too. But now that I have scared any potential readers away, I can get down to saying something that I think is quite interesting (without worrying whether it is sufficiently interesting). And it sort of relates to QE.

As a recap, it is worth reflecting (yes, again) on how QE works. While it is only possibly true that no-one knows, it is certainly the case that there is uncertainty and disagreement amongst the principal architects. As Bernanke quipped “the problem with QE is that it works in practice but it doesn’t work in theory”.

I have seen three main competing/ complimentary explanations as to how QE might work which are rather clumsily assembled on the diagram below:

Over the past month the Bank of England has published a couple of empirical studies on what effect a couple of these channels had. The first, on the portfolio balance channel (basically the belief that in buying gilts, the Bank would effectively force institutional investors into riskier assets) which most Central Bankers have relied on in public to articulate the mechanism through which QE translates into easier monetary condition, found that pension funds and insurance companies had increased corporate bond holdings and cash while reducing both gilt and equity holdings versus a counter factual simulation of their behaviour absent QE. This finding doesn’t dismiss the portfolio balance channel, but I read it as a statement that it was pretty disappointing versus the Bank’s expectations.

The second, on the bank lending channel, was pretty dismissive as to any potential empirical support. In the authors’ own words ‘we find no evidence to suggest that QE operated via a traditional bank lending channel’.

This leaves two possible transmission mechanisms: a confidence/ signalling effect, and Everything Else We Don’t Yet Understand (EEWDYU).

One could be forgiven for thinking that Mario Draghi has put in the hours in order to prove that signalling is what it is all about. After all, he delivered the most seismic easing in monetary conditions that Europe has seen in the last decade simply by deploying the phrase “whatever it takes” with a conviction few could doubt. But Europe’s inability to sustain an economic recovery to match its financial market recovery from the depths of the Eurozone crisis puts the idea that signalling is *all that* in doubt.

People seem pretty united around the idea that QE works. So, forgetting how QE might work for a second, let’s recall what QE is. It is basically a massive debt swap, exchanging long-term liabilities (aka gilts) for short-term government liabilities (aka high powered money). This is the case whether we think QE works via the portfolio balance effect, bank lending channel effect, confidence/ signalling effect or EEWDYU. In other words, if QE was worth doing, managing the term structure of the government’s liabilities appears to be a big deal.

Who is responsible for managing the term structure of the government’s liabilities? The UK Debt Management Office – an institution that used to be part of the Bank of England run by charming and capable professionals with whom I might be (I hope only temporarily) unpopular on account of my (very sensible) suggestion that they refinance the War Loan (which I recognise would be an administrative hassle for them although a very good thing for people keen to reduce the national debt and HMT interest payments).

There is also the possibility that QE actually made absolutely no difference whatsoever and has been a massive red herring.

So here’s the thing. If QE works through some mechanism other than a confidence/ signalling effect the rationale for splitting the DMO from the BoE appears defunct. Is it time for a reunion?