Can QE Be Bad For Taxpayers?
Ex Post There Are Risks, Ex Ante It’s a Win-Win.
In designing its QE programme, the ECB decided that 80 percent of the risk associated with the purchases would reside with the national central banks. But that still leaves 20 percent of the risk to be shared and since the total amount of QE purchases is going to end up being a very big number, that 20 percent is still worth discussing.
In Which I Agree With Hans-Werner Sinn
Hans-Werner Sinn has a new article about whether the European taxpayers as a whole would have to “to foot the bill should losses occur from the purchases of government bonds by the ECB.” Sinn points out that losses on these government bonds would reduce the flow of payments remitted back to central governments from the Eurosystem and so there would be a real cost to taxpayers.
He’s right. Yes, you read that correctly. He’s also spot on that “taxpayers are under no obligation to recapitalise the central bank in order to make up for the loss of profit” and he doesn’t make up a spook story to argue that this has to be done anyway or that it matters. (People losing faith in the central bank, people not understanding the left-hand-right-hand nature of central bank “recapitalisations”.)
In Which I Disagree With Sinn: Ex Ante and Ex Post Costs
So far, so good. I just want to emphasise a point that could be missed in reading Sinn’s article: It is important to distinguish between ex ante and ex post implications of QE. Consider the following from Sinn:
“any write-offs of defaulting government bonds lead to a permanent reduction in the dividends distributed to the member countries and to a decrease in the present value of these dividends in the exact amount of the write-offs. This is true regardless of whether or not accounting capital becomes negative in the process. The ‘shareholder countries’ must therefore either raise taxes or reduce expenditures.”
“there is no such thing as a free lunch for the participants of government bond purchase programmes that involve the international mutualisation of interest revenues”
I suspect most people will interpret these points as meaning that defaults on QE purchases will make taxpayers worse off than they were prior to QE being undertaken. In other words, there is a causal chain that leads from QE to higher taxes or lower spending. This really isn’t true.
The Money Machine Analogy
Let me repeat an analogy from an old blog post:
Imagine you’re a smart young rich kid. You invent a money-printing machine. You use it to magic up money to buy $100 in assets. It turns out, though, you didn’t make a great investment and the assets end up being worth only $90.
Do you (a) Be grateful that you’re $90 better off or (b) Call up your Dad to tell him you need $10 to make up your losses?
Sinn is very focused on the ex post losses of $10. But from an ex ante perspective you are $90 better off.
A Fixed Pot of Seigniorage Revenues?
But isn’t that a silly analogy? The ECB already has a money printing machine and surely it can only use it so much before bad things happen?
Last year, I met a German professor and he told me the following story. He said Willem Buiter and Ebrahim Rahbari have shown that the total amount of money the ECB can print into the future without causing inflation to go above 2 percent has a present value of €3.4 trillion. This meant, the argument went, that if you created €1 trillion in money and wasted it all on loans that default, you have reduced the amount of money that can be created in the future without causing inflation by €1 trillion. Hence, defaults on QE assets will make taxpayers worse off at some point in the future.
Sinn also cites the Buiter and Rahbari paper and while it’s a bit unclear to me what Sinn is getting at with this reference, it strikes me that the story above is perhaps something that German professors tell each other, so it’s worth examining.
First, Buiter and Rahbari’s paper does not at all do what the German professor thought it did. It simply presents a set of estimates for how much currency the Eurosystem is likely to print in the future along a path in which inflation is 2 percent. It is estimating what the likely demand for a particular form of money is going to be, not what the limit on the supply of the monetary base must be without triggering inflation. And QE will largely add to the monetary base in the form of extra reserves rather than currency.
Second, even if some learned professor did a calculation of how much money could be printed between now and the end of time without triggering inflation, there would no reason to assume that this figure is precisely the amount of money the Eurosystem is currently planning to create and thus that extra money creation via QE now has to mean less money creation later. Sinn’s comments about “Given the time path of the monetary base” and “when the monetary base remains constant over time” are completely at odds with the reality that QE has surely raised any rational person’s estimate of how much money the ECB is going to create between now and the end of time.
Third, if a learned professor ever did a calculation of how much money could be printed between now and the end of time without triggering inflation, you’d be crazy to believe them. The link between the monetary base and inflation in modern economies is almost impossible to figure out. (See my lecture notes on this topic.) It may be the case that if you create a large enough monetary base, it must eventually trigger inflation, but we don’t have any reliable rule-of-thumb to go from Eurosystem monetary base figures to future inflation.
Finally, suppose it turned out you could trust the theoretical professor’s non-existent calculation, and QE meant the ECB was printing enough money to create additional inflation, would that be so bad? Isn’t that what it’s supposed to be doing? It would be a feature, not a bug. If this helped to pull the euro area economy out of a deflationary slump, then there would be benefits in terms of employment and real incomes.
A Free Lunch?
For these reasons, Eurosystem QE may indeed be close enough to a free lunch. Normally, we need to be wary about policies that create lots of new money (and generate seigniorage revenues) because they may cause inflation. With QE, we are creating lots of money that generates new seigniorage revenues and we are hoping it causes some inflation.
From an ex post perspective, with the money created, there are risks. But then you could also point out that someone who wins a €100 million lottery is at risk of losing millions. From an ex ante perspective, QE is a win-win.