Huw Pill - The risks with excessive money creation


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A presentation held by Mr Huw Pill, Chief European Economist at Goldman Sachs, at the high level seminar "Towards a sustainable financial system" hosted by the Stockholm based think tank Global Challenge in cooperation with London School of Economics and The Swedish House of Finance on September 12th 2013.

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Huw Pill - The risks with excessive money creation

  1. 1. Goldman Sachs Global Economics, Commodities and Strategy Research 1 Huw Pill Chief European Economist +44 20 7774 8736 Goldman Sachs International September 2013 Goldman Sachs Research The Goldman Sachs Group, Inc. Investors should consider this research as only a single factor in making investment decisions. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to The risks with excessive money creation
  2. 2. Goldman Sachs Global Economics, Commodities and Strategy Research 2 Central bank balance sheets have been expanding rapidly during the financial crisis … Source: Federal Reserve, ECB, Bank of England, Bank of Japan 0 5 10 15 20 25 30 35 40 45 50 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 assets, % of GDP FED ECB BoE BoJ
  3. 3. Goldman Sachs Global Economics, Commodities and Strategy Research 3 … but while base money growth has been significant, broad money expansion is modest Source: Federal Reserve, ECB, Bank of England, Bank of Japan 0 50 100 150 200 250 300 350 400 450 500 Euro area Japan UK US % change since Aug-2007 Monetary base Broad money* * M3 in the Euro area, M4 in the UK, M2 in the US
  4. 4. Goldman Sachs Global Economics, Commodities and Strategy Research 4 Distinguishing central bank instruments • Monetary policy: – Interest-on-reserves policy (interest rate level); – Liquidity management (stock of ‘reserves’). • Credit policy (composition of central bank asset holdings)  risk of (quasi-) fiscal activities of central banks … Goodfriend (2012): “the correct way to think of central bank credit policy is a debt-financed fiscal policy”
  5. 5. Goldman Sachs Global Economics, Commodities and Strategy Research 5 Textbook definitions Source: EcPol10 Monetary policy, e.g. quantitative easing Credit policy, e.g. extending maturity of LTRO
  6. 6. Goldman Sachs Global Economics, Commodities and Strategy Research 6 Liquidity measures are benign. Efficacy of non-standard measures
  7. 7. Goldman Sachs Global Economics, Commodities and Strategy Research 7 Efficacy of non-standard measures ‘Credit’ measures are effective because of their (quasi) fiscal nature. But there are limits: when these are reached, there are consequences in terms of outlook for price stability because fiscal dominance takes hold.
  8. 8. Goldman Sachs Global Economics, Commodities and Strategy Research 8 Central Bank NPV of Seigniorage Fiscal Stance (end-2011) α = 0.5 α = 1 Debt level Deficit ECB EUR 1.4 tn EUR 2.5 tn EUR 6.3 tn EUR 305.5 bn FED USD 1.5 tn USD 2.7 tn USD 11.0 tn USD 1,259.5 bn BoJ JPY 142 tn JPY 259 tn JPY 612.6 tn JPY 41,489.1 bn BoE GBP 67 bn GBP 122 bn GBP1.2 tn GBP 103.0 bn With Source: IMF World Economic Outlook, GS EWA 11/35 Numerical examples of quasi-fiscal capacity of central banks …
  9. 9. Goldman Sachs Global Economics, Commodities and Strategy Research 9 Estimates of capitalised value of non-inflationary monetary income are large … … but this is not ‘manna from heaven’. Credit measures imply a pre-emption / diversion of monetary income …
  10. 10. Goldman Sachs Global Economics, Commodities and Strategy Research 10 The alchemy of the Outright Monetary Transactions programme … Default risk premium High sovereign yield Fiscal position unsustain- able Elevated credit risk No default risk premium Low sovereign yield Stronger fiscal position Eliminate credit risk ‘Bad’ equilibrium OMT ‘Good’ equilibrium Central bank issues put options on sovereign debt
  11. 11. Goldman Sachs Global Economics, Commodities and Strategy Research 11 … involves solving a coordination failure in the private sector Central bank rhetoric alone can shift to a new (and Pareto-superior) focal point. ECB accepts credit risk in an ‘off-balance sheet’ form through writing derivative contracts (put options on peripheral sovereign debt) … … but that risk ‘disappears’ in the new equilibrium.
  12. 12. Goldman Sachs Global Economics, Commodities and Strategy Research 12 Summing up … • Central bank’s are banks. • Focus should be credit quality of their asset portfolio. • If that deteriorates (and they are not adequately compensated), then their balance sheet may no longer ‘add up’ … … implying ‘fiscal dominance’ and ultimately inflation. • This is not inevitable … … but the main danger is that central banks assume more and more responsibility and ultimately tries to solve problems it cannot. • Focus on the quality of assets, not the quantity of money creation.
  13. 13. Goldman Sachs Global Economics, Commodities and Strategy Research 13 I, Huw Pill, hereby certify that all of the views expressed in this report accurately reflect my personal views, which have not been influenced by considerations of the firm’s business or client relationships. Disclosures Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs on a global basis. Analysts based in Goldman Sachs offices around the w orld produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs Australia Pty Ltd (ABN 21 006 797 897); in Brazil by Goldman Sachs do Brasil Corretora de Títulos e Valores Mobiliários S.A.; in Canada by Goldman Sachs Canada & Co. regarding Canadian equities and by Goldman Sachs & Co. 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