 Can QE rescue the Eurozone? Well, first of all, can I say thank you very, very much for inviting me here to speak. I've spoken on these issues in various parts of the world, but there's nowhere I would rather be, particularly as I know the weather is always like this in Dublin. So it's really, really a great pleasure and honor to be here with friends to talk about these issues. So this presentation has the very dramatic title of Can QE Save the Eurozone. It's slightly melodramatic, although I think there is an element of truth in it which I want to outline. But perhaps before I start, I should say I'm reasonably optimistic about the prospects for the Eurozone in the sense that we've now had a pretty material decline in the oil price. We've had a significant fall in the value of the euro. And in many of the most troubled economies in the Eurozone, there's been a very big decline in their government bond yields and interest rates and credit spreads in the last 18 months. Now, those three factors are all a significant stimulus to the economy. And beliefs and expectations in economies like particularly in continental Europe and Italy and France are extremely pessimistic. And the good thing about that is if people are extremely pessimistic, it doesn't take very much actually to positively surprise them. So I would say that we have half a chance that things will start to improve. However, I think there's been a sort of odd trap in the policy discussion in the Eurozone, which is it's a great danger to say that if you get an economic recovery, your policies have been successful. And I'll just give a very simple analogy. It seems to me policy making the Eurozone is a bit like somebody visiting their local GP with all of the symptoms of the flu. A man goes into the GP's surgery. The GP clobbers him over the head a few times, keeps on hitting him on the head and he's slightly bewildered. And the GP takes out his pen, writes him a prescription for some antibiotics and sends him on his way. Slightly baffled, takes his antibiotics, cured of his symptoms of the flu, returned several weeks later to the GP, obviously feeling a little bit circumspect, not too sure what the GP is going to do. The GP says, you know, I assume all the flu symptoms have gone. Isn't it amazing what you can achieve with a good beating, right? Now, the beating there for me is austerity. And the antibiotics are monetary policy, right? Now, what I'd like to see is better antibiotics and a little bit less of the kind of random beatings. And that's really what I'm going to talk about. So we have to be, so really what I'm saying is, is not that there won't be a recovery in the Eurozone with the status quo, there probably will be, but that the status quo should definitely not be acceptable. And there could be done an awful lot better than this. And that's really the key point, particularly as many examples like Ireland are being used as examples of success, which I think is misplaced for exactly the analogy and the reasons of the analogy that I've given. Okay, so first of all, I just like to stand back a little bit and make some observations about economic policy, which I think have been revealed through the crisis. The two here are interesting. The first one is, and this is really an indictment of economic policymaking, is if you look globally, there has been no consensus over what to do with fiscal policy. Now there's a very legitimate question to pose to all economists, which is, how have you had centuries to think about this problem? And you still can't agree what the right thing to do in a recession with fiscal policy is, right? So if you think that one of the key functions of economic policy is to prevent recessions or generate a recovery from recessions. So all of the major regions and geographies of the world have pursued completely different fiscal policies. And I'll come back to that, but that's a very curious state of affairs. The second one is that if you look at central banks, what's quite extraordinary is actually the policies of central banking and the tools of central banking haven't actually changed since the very first central banks started operating. So if you look at the Swedish Riksbank, which I think they're better experts here than me on central banking, but I think it's one of the first, if not the first, recognized central bank. The very first central banks in the late 1700s, what did they do? They did two things. They started and helped to finance the government. So they started government bond markets. That's actually QE, right? So quantitative easing is exactly what central banks did at their very inception, which is buying government bonds. And then the second thing they did was provide liquidity to the banking system. And that's right at the origins. Now the interesting thing is, is that despite all the fancy names and the complicated ways in which they do it, essentially they're doing exactly the same two things today. Now that's quite extraordinary. Central banks went from being relatively small, not very significant institutions to being the principal institutions of economic policymaking. And they actually haven't got any new tools. Nobody has really looked at and said, if you had a blank sheet of paper, how would you organize a central bank today? So those are two, for me, very, very striking observations. Why can't we agree what to do with fiscal policy after all this time? And why has there been no innovation in the tools of central banking? And I would like to propose really one innovation in the tools of central banking, which I think would be a lot more effective. I should also say the outset that a lot of this presentation will now get involved in very obtuse and abstract discussions of distinction between fiscal and monetary policy. That's because I have to cover the fact that my policy prescription is blindingly obvious. So when you look at it, it's kind of, and in fact, no economist ever says it won't work. So when you explain it to people, everybody pretty much accepts you know, actually that would almost certainly work. But for some reason, economists and economic policy makers, particularly when we're confronted by very grave issues, we don't like the idea of very simple policies that would work with almost 100% certainty. Now that in of itself is a very interesting psychological question. I suspect actually is a psychological problem, rather than being an economic one. Anyway, hopefully I'll convince you of that and we can discuss that during the Q&A. So the first thing we have to get out of the way is what is wrong with the Eurozone? Because to anybody observing it, or if you're not a specialist or you don't follow all of the policy dates, it's profoundly confusing. You have all of these different explanations from the fact that the Greeks don't work hard, the Italian legal system takes too long to get things through court. All of these complicated labor market reform pensions, what is the root cause? Well there are really two issues that economic policy tries to tackle. The first one is the economic cycle. So economic policy tries to prevent recessions and when a recession occurs, it tries to generate recovery. And the second thing that policy focuses on is the long-term rate of GDP growth. Now that's what all the structural reform is about. It's about long-term rate of GDP growth. So when you look at the demography which determines labor supply, determines the burden of people in retirement, that's really about long-term growth rates. That doesn't cause, demography doesn't cause financial panics and major recessions. It determines growth in the very long term. That's also true of labor markets. That's also true of welfare systems. Now the problem cyclically, so none of that explains labor market structural reform. None of that explains why the Eurozone is in a recession-stroke depression, right? That is about pessimism and optimism. It really is as simple as that. Now pessimism is effectively what Mario Draghi made an important speech recently at Jackson Hole in the United States. He said there isn't enough spending, there isn't enough aggregate demand in the Eurozone. Now that all that means is households and businesses aren't spending enough. Now why aren't they spending enough is because they're pessimistic. They're pessimistic, it's rational pessimism because their pessimism is self-fulfilling. All right, so if I'm a worker, I'm worried that I'm gonna lose my job or I'm worried that my wages are gonna be cut. So I don't spend very much. If I'm a firm, I think demand for my goods and services is gonna be weak, I think my profits are gonna be weak so I don't invest. If I don't invest and I don't employ, the labor market is right to think that their wages are gonna be cut in this job insecurity. It's very simple. So what really needs to be tackled. Now the structural issue is complicated and ultimately in my view, should be that the remit of member states should decide what their long run rates of growth are by setting their policies. But macroeconomic policy really needs to tackle this issue of pessimism and insufficient spending. Now if you're studying for the leaving certificate, the answer to this problem is actually very straightforward. When I did economics at leaving cert many, many years ago, it would have been a very simple solution which is you cut taxes, you increase government spending and you cut interest rates. So the first question we have to ask ourselves is why isn't that happening? Why hasn't that been the policy prescription? That is in effect what America did. America, very, very late in the economic recovery they started to cut back on government spending but essentially the both Bush in 2008 and then the first thing that Obama did was cut taxes, increased government spending and the Fed had been slashing interest rates. And it worked. Newest economy has recovered it. They're now getting within 18 months if things continue, America will be at full employment. So textbook economic policy has worked in the United States. So the interesting question then is why hasn't the Eurozone followed what the United States did? Well, there's really I think two reasons. The first one is the fiscal policy is almost illegal and there's sort of good reason for that which is you don't have a federal government. So there's a major problem is how would you actually organize fiscal policy in the Eurozone if it isn't federalized? Because otherwise any individual country can start setting policies independently. So the only way they could get, they could really get agreement and particularly they very badly in my view made the fiscal compact in the midst of a crisis has effectively neutered fiscal policy. There simply isn't enough flexibility to generate the kind of levels of demand that are necessary. So I met the senior official that the Italian finance ministry, the discussions the Italians are having with the European commissioner over 0.10 of a percentage point of their budget deficit. That doesn't even show up on an econometric model. That is just simply statistical noise. If you wanna have a fiscal impact you need to do percentage points of GDP. So fiscal policy is severely hampered. Now is monetary policy similarly hampered? Now the problems with monetary policy have really arisen because and this is why I wanna talk about what would otherwise be an issue of semantics. This distinction between fiscal and monetary policy. So when European institutions were being put in place in order to effectively give up sovereignty over the monetary authorities it was very important that the delineation between fiscal and monetary policy was made clear. That is necessary effectively for the central bank to operate independently. If somehow fiscal policy could hijack monetary policy the ECB wouldn't be able to operate with independence. So the inability to coordinate fiscal policy means it's extremely important that that legal distinction between fiscal and monetary policy is maintained. Now part of the problem in the Eurozone and this is what I wanna come onto in a minute is to illustrate that in a financial crisis the distinction between fiscal and monetary policy effectively collapses. And actually monetary policy becomes primary. And I'll come back to that in a minute. So the questions then that arise are have we got a core fundamental weakness in the structure of the Eurozone? Because if in a financial crisis the distinction between monetary and fiscal policy collapse how do we run a system where the two have to be separate legally? So is there a legal conflict with a fundamental need for counter cyclical demand management so how to solve the recession? And I will end hopefully by illustrating that I do actually think this circle can be squared. In other words there is a Eurozone specific policy that can solve this problem for us. Okay so the distinction between fiscal and monetary policy. Now most of us if the two terms mean much at all fiscal policy is understood as quite simply referring to taxation, government expenditure and transfer payments by government. Monetary policy typically just is official interest rates so the central bank changes interest rates. It can either raise the interest rate or cut interest rates. In that world everything seemed pretty clear. There appears superficially at least to be a clear distinction between the two. Now interestingly if there are any economists or theoretical economists here this actual distinction doesn't hold very well in economic theory so if you read economic theory actually economists are very vague about this. Mervin King was asked about the sort of policies I'm gonna refer to and he replied by saying no that's fiscal policy and then actually if you quiz him on the precise distinction it starts to become very very vague as to what the distinction is. In fact a lot of theoretical models effectively make the two the same. That's really just though for the economists to bear in mind. I think we can make a relatively clear distinction. And the first one monetary policy I think you can clearly say has got to do with the issuance of currency. So at least the role of monetary policy can be clearly defined there. And the second thing I think that we start to realize when you look into it is that actually the distinction is not really an abstract theoretical one. It's an institutional one. So monetary policy is in fact what we say the central bank should do. And fiscal policy is actually what we say the government should do. So this is important though because for a solution to be legal and viable in the Eurozone it has to be true to that distinction. So it has to be clearly within the remit of the European central bank operating independently of governments. That's absolutely key. And it has to involve the issuance of currency. In my view that becomes indisputably monetary policy. If it's being done by the ECB independently of the behavior of governments and involves the issuance of currency that to me is both to the legal letter and also to the spirit of the definition. Okay, now before I come to the specific proposal I just wanna illustrate this point about what happens in a financial crisis. So why the distinction between fiscal and monetary policy collapses? So previously we had this apparently clear distinction tax expenditure is fiscal creation of money and interest rates is the central bank. There's a profound observation about political organization in the work of David Hume writing in the 1700s. And again, political organization is probably the one area which has been even slower to move in terms of genuine innovation than economics which is not necessarily a bad thing. Now Hume argues that there are three spontaneous institutions of social organization. So any society that you look at will have these three institutions. And what I really wanna suggest to you is that in a financial crisis you realize that sovereignty actually depends on our ability to issue currency. So it's something that we ignore most of the time and it only very rarely becomes relevant to a society. But actually the ability to issue currency is extremely important. Money today is the financial system. Now beneath the financial system there are effectively in most societies developed countries two contractual obligations. One is that the state will support deposits to varying magnitude, but we have to have deposit guarantees. Otherwise we will have systematic collapse and threaten social stability. And this is only made explicit in recent developments but it's actually always there. And if Milton Friedman talks about this is one of the most important changes in the US economy after the Great Depression was the introduction to deposit insurance. It really ended the kind of very frequent banking panics that used to occur in the 1800s. The second implicit guarantee that is absolute is that the government won't default on its debt. Now effectively what happened in the, now the interesting question is can a sovereign state do that if it doesn't control money? I don't think you can. Because the only reason deposit insurance is credible is if I can issue currency. If I can issue currency I can say your deposits are absolutely guaranteed. If I can issue currency I can say your government debt is absolutely guaranteed. Now the financial system depends on those two things. If you take away or threaten those two obligations the financial system breaks down and society breaks down. Certainly the financial system as it's been constructed. Now the problem in the Eurozone crisis was exactly those two fundamental obligations came into question. And that is really what's thrown apart the institutional structure. In other words people did not know if their deposits were safe and they did not know if government obligations would be honored. Now I should say in economic theory actually there is an assumption that the state has primacy over the central bank. So if anybody looks in an economic textbook it's assumed that ultimately the central bank is consolidated into the government. So if you look at for example the profits that the Bank of England gets made gets remitted to the UK Treasury, the Fed and during the financial crisis you know finance minister and central bank governor would stand side by side and that is how things operate. What is genuinely unique about the Eurozone is that the central bank has legal primacy over member states. Now that is in many ways is quite extraordinary. So the truth is it isn't Angela Merkel is definitively not the most important decision maker in the Eurozone. The single most important decision maker is the president of the European Central Bank. Absolutely because that is actually the only European institution. And not only that there's a fascinating aspect of the ECB's regulations which is the ECB can compel member states to increase its capital. So the ECB can actually say to them after the executive council of the ECB has a vote they can just command and increase in their capital. And this is precisely why I've in London had meetings with new policy makers coming into various European governments when Hollande came to power his economy minister came over to London similarly initially and they outline all their policies and I always say to them have you met with Mario Draghi yet because that's the most important meeting because actually he ultimately determines what's going to happen here. There is a your margin of movement and this of course does throw up huge issues of democratic legitimacy. I think it's also for me very revealing from a purely political perspective. I mean how many members of the governing council for example do we know? Does anybody know who the head of the Portuguese central bank is? These are very interesting questions because I actually think not nearly enough attention is being paid to who those people are. You know the president of the Irish central bank is an extremely important individual. Anybody who influences the decision making of this body in key moments in time is of critical political importance. Right, so what's the solution? What I'd just like to do very quickly is describe why I think monetary policy has become central to economic policymaking dominant relative to fiscal policy. And I just wanted to very simply outline what the pros and cons of monetary and fiscal policy are which then I think is a neat way of framing the policy recommendation that myself and others are suggesting in the Eurozone but also actually as a policy that could be broadened and applied to other countries as well. Now you can see there immediately that there is much more in favor of monetary policy than there is against it and relative to fiscal policy as well. I'll just go through some of the key points. So the one good thing about fiscal policy is that it can affect spending directly. So we're the Irish government to announce overnight that there's gonna be a cut in income taxes with immediate effect. That would be a boost to spending in the economy pretty much immediately. Even if they announced it, if the Eurozone announced a huge fiscal stimulus, you would immediately get an increase in economic activity because firms would immediately anticipate that there's gonna be an increase in their sales and improvement in their profits. People would already anticipate an increase in demand. So the one good thing about fiscal policy is that it affects spending directly. The second thing is it can be used to support other objectives like infrastructure, like inequality. The problem is, and this is a fatal flaw in fiscal policy, goes back to the point that people can't agree on it. So it would be great, but we can't agree on it. So every country pursues different routes, different parts of the political spectrum, argue about it, vested interests get involved. And as a result, it tends not to be timely. So what happens is infrastructure is a great idea. If infrastructure is a good thing to do, but it's not a good way to manage a recession because infrastructure takes lots of planning if it's to be done well. It takes lots of time to execute. And it can become hostage to vested interests. So I'm very much in favor of infrastructure spending. I just don't think it's the right way to stop processions or indeed to generate recoveries. It's simply not timely. Fiscal policy is very difficult to coordinate it. And as I referred to, there are vested interests. Now, what about monetary policy? Well, almost everything is the opposite. So the wonderful thing about monetary policy is you can just have a meeting. You can even have a conference call and you can do it instantaneously. So decision making is extremely quick. There is huge consensus actually about what to do. So pretty much everywhere in the world has broadly done similar things. I mean, they can argue over QE or LTROs, but effectively they've all been doing the same thing. So there's consensus. It's independent of politics. And so it isn't perceived to be influenced by vested interests. In that sense, it's not ideological. Now, the fatal flaw in a sense or the current problem that's being revealed though with monetary policy is this key point. Its effects are indirect. If the ECB announces a QE program tomorrow, it actually doesn't affect any of our disposable incomes. And in fact, when you think about it, it works in a very, very convoluted and indirect way, which is it requires people to change their balance sheets. So it's trying to encourage people to borrow. It's negative for savers. And it tries to move asset prices so they try to get the stock market up. My housing market up. They try and get the currency down. So indirectly affect people's behavior. And in fact, we've started to realize that there are major limits to this. In the world, when interest rates were a 10% and you could slash interest rates, then it had a very pronounced and immediate effect. But when interest rates are pretty close to zero, when people don't want to borrow, when people actually want to save, and asset prices only affect a small segment of the population, particularly if housing itself is being influenced by other factors. So the solution here, it seems to me, is quite clear, which is we want to keep what's good about monetary policy. So we want it to be, you are able to make decisions extremely quickly. You want it to be credible and independent, so subject to an inflation target. Everybody, broadly, there is a huge consensus that we want to have a stable rate of inflation. Everybody can agree on that across ideological burdens. We want it to operate independently of a political cycle. But we need to solve this problem. It can't be indirect. We want it to be direct. We want it to affect spending immediately in the way that interest rates used to it. People familiar with the UK, where people borrowed variable rate mortgages, it was effectively, soon as the Bank of England cut interest rates, households cash flow got improved instantaneously. We need to find a way where monetary policy increases people's spending immediately. So that comes to what John Mulbarret, professor of economics at Oxford, has described as QE for the people. And this is the deceptively simple solution, which, in my view, largely poses a presentational problem. It's a bit like if a kind of eight-year-old, for some reason, kind of wanders into some very serious discussion about economics, and here's Mario Draghi and Ben Monaghi having this discussion. They're all saying there isn't enough aggregate demand. What does that mean? They're not spending enough. And the eight-year-old just says, why don't you just give them more money? Well, in fact, I would like to hear their answer. They'd probably tell them, sorry, you don't understand. It's much more complicated than that. That is, in effect, what Mark Blythe and I and a number of others are recommending, which is that you have a simple solution, which is that the ECB itself prints money and makes transfers directly to the household sector. John Mulbarret at Oxford has suggested that you could entirely avoid using governments if you use the electoral register, which is public information. And they just post a check. So post a check of 1,000 euros to everyone on the electoral register in the Eurozone. Now, what will happen? Would it work? The really intriguing thing is I haven't met an economist who doesn't think it would work. So it's pretty. It doesn't matter what type of an economist you are. I mean, some of them desperately try to say they'd kind of be an instantaneous increase in inflation without any increase in activity. Even very convoluted models show that, under very easy assumptions, it'll affect spending. All of the empirical evidence suggests it will increase spending. So George W. Bush, God bless him, did something very similar, probably not realizing this is what he was doing. And he did it in 2008. But they called it tax rebates. Now, that's just a name. You could call it a tax rebate if you want to call it a tax rebate, but that's just framing. That's just a description. They gave people a check, and the Fed was doing QE at the same time. That's implicitly that's the same thing. All of the evidence said it increased spending. Had they done a lot more and had they done it continuously, it would have increased spending even more. So the Americans have used tax rebates many times in the past, and they've been successful. Now, what most people worry about immediately is that it would cause inflation. And this is worth thinking about a little bit. Firstly, we're recommending it should be done subject to the inflation target. So we're doing it to help the ECB actually get somewhere close to their target. So the first key point is that the ECB is miles away from 2%, which was their own definition of price stability. But I personally don't think you want to try and create inflation. Inflation actually isn't the problem. Problems demand. So I don't really mind if inflation goes up or down. I just want spending to occur, and economic recovery to be sustained, investment spending, and employment to be created. And what happens to prices is highly unknown. There's not going to be runaway inflation. There's no circumstance in which that's plausible. We're talking about maybe 2%, 3% points of GDP in much smaller scale than quantitative easing. Quantitative easing, if you look at the United States, the UK, and Japan, has been 30% to 40% of GDP. So if you're worried about inflationary effects for money printing, worry about QE. Here are two, three percentage points on any simple economic model. Two or three percentage points of GDP are going to have a dramatic impact on the economy. And you would persist in doing that. Now, is it legal? I hope I've convinced you that it's legal, because it seems to me that the distinction between fiscal and monetary policy is about whether it's got to do with printing money or not. That is the clear delineation. And this would involve printing money by the central bank. In the context of Europe, the distinction between fiscal and monetary policy is defined institutionally. So it's very, very clear that the ECB is not allowed to finance the activities of governments. Well, that's not financing the activity of governments. So this does not depend on the tax policy of Italy or Italy's budget or the French, whether France meets its fiscal targets or not, or what Germany does with its fiscal targets. This would be done independently by the ECB, direct to the population of Europe. I think in many ways, actually, it is fairer than interest rate cuts, in fact. So again, people say, but wouldn't you be favoring how do you decide how much to do? The obvious approach is to do it equally to all citizens. That's clear. You just do it equally. Now, when people talk about issues of fairness, that, to me, is a lot fairer than changing interest rates. I mean, when you change interest rates, there's a very clear winners and losers. So you are punishing if you want to use moralistic terminology of people who save and favoring those who've been borrowing. If you do QE and you try to drive up asset prices, you're favoring the holders of assets. So these all have distributional consequences. This is why, when you actually start to think about what's fiscal and monetary policy, you really do discover that the distinction is institutional definition. It's very difficult to make the distinction in the abstract. So I think it is rigorously legal. Now, the interesting question then is, why not? And why hasn't it been done elsewhere? Well, as I said, alluded to, policies very similar to this have been done elsewhere. Could it happen in the eurozone how probable is that? The honest answer is, I don't know. But I'm encouraged because a lot of serious people are supporting the view. So to give some examples, you now have two former members of the Monetary Policy Committee of the Bank of England who are advocates. So Willem Boeiter, who's a very renowned Dutch economist and was a member of the Monetary Policy Committee in the UK, has written papers effectively arguing in a very theoretical way. I'd only recommend them if you like reading through lots of equations, but he has written articles advocating these policies. Sushil Wadwani, another member of the Monetary Policy Committee, believes that the Bank of England should effectively have the ability to do this. And then Lord Turner, who was the chairman of the FSA, has advocated something very, very close and similar to this. A number of economists at Bokoni University in Milan are advocating something similar. So it is gathering traction. I suspect the main resistance is what I alluded to right at the outset, which is a psychological one. The first thing is that if the ECB were to do it, there's clearly be some administrative challenges. So actually getting the checks out would pose some challenges. So I think innovative ideas in that regard are all welcome. I don't know whether an electoral register is robust enough a means, but how one would actually administer the issue, I think, is a very material challenge. But I think the more profound one is, populations are going to turn around and say, why on earth didn't you do this sooner? There's going to be a lot of very, very embarrassed economists and policymakers who are going to be sitting red faced as they've come up with loads of acronyms that nobody understands, hugely convoluted programs using hundreds of billions, trillions of euros on their balance sheet when all it required was actually two or 3% of GDP and a transfer to most of the household sector. And actually recession could have ended quite quickly and a lot of human misery prevented. And actually that would be quite embarrassing. Anyway, on that cheery note, I'll leave it there.