Centre for Banking, Finance and Sustainable Development Management School Policy News

8 February 2012 Volume 3, Issue 1 MP & Banking Expert Call For Change to BoE Policy Replace Bond Purchases with Solar PV Purchases—SUMMARY

As the Bank of England moves Professor Richard A. Werner, mote environmental protec- closer towards announcing an Director of the Centre for tion, to stabilise the econo- unprecedented third round of Banking, Finance and Sustaina- my, and to create hundreds

‘’, experts of thousands of jobs. Invest-

are calling for this newly creat- ”Many would like money ment in solar PV and energy ed money to be used more efficiency, for example, would creation to be used to help Inside this issue: productively and effectively to reduce fuel poverty, cut cli- the wider economy and envi- achieve key social and environ- mate emissions, and get many Q: How does QE work? mental objectives. During the ronment.” people back to work.” Pro- Why do we need a last round of Quantitative fessor Werner and the Green third round? Why in- Easing (’QE’) the Bank of Eng- ble Development at the Uni- New Deal Group, of which ject the money only land purchased £275bn worth versity of Southampton: Caroline Lucas is a Member, of government bonds with “Many people would like mon- pointed out that money crea- into the banks? money it newly created. As ey creation to be used to help tion is a public privilege—so A: QE aims to expand the the Bank of England prepares the wider economy directly using it to benefit the public amount of money circulat- the ground to inject a likely and to implement some badly and the environment seems ing in the economy. There £50bn to £75bn into the econ- needed green projects that only right. They argued that omy, the UK’s Green Party would enhance the sustainabil- instead of giving money to are better ways than the MP, Caroline Lucas, and ity of the economy and im- banks who fail to lend it on, current implementation of Southampton University bank- prove the environment—as the central bank could pay for the policy. Giving the ing expert Professor Richard well as create new jobs.” billions worth of photovoltaic money to banks is not Werner, are calling for this Green MP Caroline Lucas said: and energy-efficiency installa- money injection to be used for “I warmly welcome this im- tions across the country. This enough. We now need green projects that directly portant contribution to the would reduce electricity ‘Green QE’ to create jobs improve the environment and debate. Professor Werner costs, create jobs and get the and the wider economy. long-term quality of life, while shows that it is possible for UK ahead in its plans to cut creating many new jobs. Said Green QE to be used to pro- carbon emissions.

The and the Bank of England have adopted a policy they FULL REPORT call ‘Quantitative Easing’. But they Time for Green Quantitative Easing have focused on giving more re- serves to banks in the hope that How to Generate Green, Sustainable Growth at No Cost they will lend more money to the economy. They do this, because By Richard Werner, Professor of International Banking they know that most of the money in the economy is not created by the central bank but the commercial At the Bank of England’s Janu- servers will wonder whether in a brochure entitled “putting banks (’credit creation’). ary MPC meeting, several this is because quantitative more money into our econo- The Centre argues that while members supported further easing has been successful. my to boost spending”, the efforts to boost bank lending should measures to boost the econo- They will also wonder how Bank of England explained the be stepped up, the Bank of England my, suggesting that the Bank of quantitative easing is sup- policy as follows: “The Bank can kick-start the process and im- plement true quantitative easing by England could well announce posed to work, and whether creates money and uses it to boosting its own credit creation and this week a third round of what there aren’t better ways to buy assets such as govern- injecting money directly into the it has called ‘quantitative eas- spend our money and kick- ment bonds and high-quality wider economy. The most efficient ing’, following from the £200 start the economy. debt from private compa- and sustainable way of doing so is billion of money injected in In 2009, soon after quanti- nies…. resulting in more via a policy of Green QE, whereby the BoE buys green assets that 2009 and the £75billion last tative easing was first an- money in the wider econo- enhance the environment and re- year. If it does so, many ob- nounced, the Bank of England duce the carbon footprint. continued on page 2

Policy News It’s Time for ‘Green QE’… (cont’d from p. 1)

my”. other. The drying up of wholesale bank credit after they have al- How exactly does this in- funds pushed several banks over lowed such disasters to happen, creased money enter the econo- the edge and is a problem that has and just when bank credit was my and how does it boost spend- not been fully resolved. already contracting. ing? According to the Bank of Consequently, the banks have As a result, we find today that England “Banks end up with more since 2008 been far more risk- banks carry excess reserves and reserves as well as the money averse than in prior years. Under often also excess capital. In other deposited with them. Increased such circumstances, bankers tend words, they are lending far less reserves mean banks can increase to cut back particularly lending to than they could presently lend, their lending to households and small firms – since considered given their reserves and capital. businesses, making it easier to individually, they each are riskier Enter ‘quantitative eas- finance spending.” than a larger firm in the same ing’ (QE). As the Bank of England Thus the transmission of this industry. Taken together however explains, it has been implement- policy is said to take place mainly a diversified portfolio of small ing it in order to give more mon- via the banking system. By this firms should be a safer bet, as they ey to banks in the hope that they token, we can measure the suc- tend to invest in producing new will extend more credit to the cess of quantitative easing by economy. Since banks already examining bank credit growth. A are lending far less than they broad measure, so-called M4 “The Japanese failure of QE could, and are sitting on excess Lending, contracted by between holds lessons for the UK. money, such QE won’t boost 3% and 4% on a year-on-year bank lending. It can to some Banks say there is no loan basis in the last quarter of 2011 – extent monetise government the worst performance on rec- demand. Small firms would spending, but remains modest in “The government’s ord. Over the past year, bank like to obtain credit.” size for this purpose. This has lending has stagnated and espe- been my long-standing criticism cially bank lending to small and of the Bank of Japan’s policies attempts at getting medium-sized enterprises has goods and services, not financial during the 1990s. contracted. M4 has speculation. But this argument also decelerated sharply. Thus it does not sway individual loan offic- The Lessons from Japan banks to increase would seem that neither QE nor ers or, rather, the automated The Japanese failure holds les- ‘Project Merlin’, the government’s credit scoring systems installed by sons for the UK, not least be- lending to small firms attempt at getting banks to in- Britain’s five banks, which neglect cause the Bank of England chose crease lending to small firms, have the systemic implications of collec- to model its policy on Japan’s been successful. tive bank behaviour. Thus banks ‘quantitative easing’. For almost have not been This should not come as a big have cut back lending to small an entire decade after the Japa- surprise. Until 2007, bank regula- firms. nese speculative bubble had tors (the Bank of England, the Meanwhile, the bankers pro- burst in 1990, the Japanese cen- successful.” FSA and the Treasury) stood by claim that they would like to in- tral bank maintained that it could as banks increased lending rapidly, crease lending to ‘creditworthy’ not do anything to stimulate the without much consideration for borrowers—in the view of the economy but lower interest whether the money was used for banks basically the large firms. But rates. This, I had warned earlier, sustainable, productive purposes these don’t need the money and in would not work as banks were (ensuring that loans remain per- any case are not dependent on burdened with bad debts and risk forming) or whether it was used banks for funding. So bank credit -adverse. The Bank of Japan re- for asset market speculation. If growth has stagnated and last year peated the banks’ justification left to their own devices, in good turned negative, meaning that that there was no demand for times banks find it more attrac- banks are on a net basis withdraw- bank loans among firms—the tive to lend for speculation, which ing money from the economy. large ones. So bank credit generates larger and faster profits This problem is not helped by the growth dropped to zero and for while requiring less work and ill-timed attempts by regulators to years even shrank. analysis by the bankers. Thus require banks to raise more capi- On 19 March 2001 the Japa- bank credit for asset and financial tal or meet other regulatory re- nese central bank, having presid- transactions ballooned. quirements that make it harder or ed over a decade of sub-standard This created the property and less attractive for them to lend. growth (Japan’s first ‘lost decade’ asset bubble that ultimately Proposals to tighten bank regu- of the 1990s), announced that it brought down many UK banks. lation are worthwhile, as long as would solve the problem of stag- When the bubble burst, banks they are well-timed: before a cred- nating bank credit growth by started to suffer from non- it-fuelled asset bubble and subse- creating new money and provid- performing loans and exposure to quent banking bust happens. Sadly, ing it in vast quantities to the worthless ‘toxic waste’ type of in the last thirty years regulators Japanese banks. These already assets. Hence banks became sus- and governments have persistently had large excess reserves before Page 2 picious about lending to each chosen to tighten the rules on this policy was implemented–

2

Volume 3, Issue 1 It’s Time for ‘Green QE’… (cont’d from p. 2) much later dubbed ‘QE’ by the the borrower had deposited with politicians think ‘quantitative eas- Bank of Japan. it the amount of the loan, by simp- ing’ is supposed to work. How So the policy to increase ly entering the relevant number can this be done in practice? In banks’ reserves in their accounts into the borrower’s account. This the words of the Bank of Eng- with the central bank, predicta- adds new deposits to the money land’s pamphlet on QE, the stand- bly, had little effect. Bank credit supply, and this is how almost all ard way for a central bank to get continued to stagnate for anoth- money is created ‘out of nothing’ new money into circulation is to er decade, and today continues by the banks.* Hence the conven- ‘create money and use it to buy to record close to zero growth. tional thinking among central assets…’. Japan has now entered the third bankers that any new money that In practice, conservative cen- decade of economic stagnation, the central bank wishes to inject in tral bankers have focused on as central bank policy failed to order to stimulate the economy government bonds and other kick-start bank credit growth and should be given to the banks. financial securities held by banks. the money supply. But this does not make much But to the extent that they buy Most observers who think sense at a time when banks are them from the banks, the banks about ‘quantitative easing’ imme- risk-averse due to actual or per- are merely exchanging one asset diately grasp the basic premise, ceived non-performing loans, and for another, and all QE is doing is namely that an increased money bank credit growth is already stag- to help banks increase the liquidi- supply in the economy should nating. Banks currently are vastly ty of their portfolios by getting stimulate demand. They are, ‘underloaned’, i.e. they could lend rid of longer-dated and slightly however, often surprised by far more money than they are less liquid assets and raising cash. central banks’ insistence that any actually doing, given their reserves How can the central bank newly created money is injected and capital. Adding to their re- inject money without it getting mainly by giving it to the banks – stuck in the bottle neck that cur- *“The actual especially when banks had rently passes as our banking sys- demonstrated in prior years that tem? As I already suggested in they are not good at allocating 1994 to the Bank of Japan, a cen- process of money money to productive and useful tral bank could start by expanding purposes or in a sustainable way. the range of assets it purchases. I creation takes Why, they often wonder, not pointed out at the time that To- inject the new money directly kyo, where the Bank of Japan is into the economy, and make sure situated, has the lowest ratio of place primarily in it is spent in a socially useful way park space per inhabitant of all that is considered desirable by major cities in the world. At the the majority? same time property prices had banks.” There is a historical reason for dropped by 80% and banks, as central banks’ preference to hand elsewhere using land as collateral, (Federal Reserve) money to banks and not inject it Credit creation for productive were more or less bust. directly. Tangible paper money in purposes increases demand So why should the Bank of circulation, which is issued by the without stirring inflation. Japan not simply create money central bank, accounts for only and purchase land on the 3% of the money supply in the serves and capital thus is not likely market, and then proceed to UK – and a similar proportion in to persuade them to create more create public parks on the land? most industrialised economies. credit. The policy would serve to inject So who creates and allocates the new money into the economy remaining 97%? Since the majori- Bypassing the Moribund Banks without it getting stuck in the ty of the population believes the I have proposed two ways to get banking system, and thus would money supply to be created and round this problem. One boosts increase domestic demand by the allocated by the central bank or bank credit directly (available as a same amount as the money crea- the government, it often comes discussion paper of this Centre, tion. At the same time, those ‘BoJ as a surprise to observers to find CBFSD 2010) and the other cir- parks’ would enhance the quality that it is profit-oriented enterprises cumvents the moribund banking of life, improve air quality, reduce that have a licence to create the system entirely. Here I would like Tokyo’s carbon footprint and money supply. to discuss the latter: It seems revive the property market, while You guessed it: these are the obvious that in such times and also boosting the banking system. commercial banks. They do this circumstances the central bank The equivalent of a £275 bn injec- through the process of extending and the government have a duty tion of new money, as already has credit – what is commonly re- to expand the money supply, by happened in the UK, if done the ferred to as ‘lending’ by banks. injecting money directly into the right way could create hundreds As it turns out, there is no such economy, without relying on the of thousands of jobs and improve thing as a ‘bank loan’, since when banks. This is in any case how the environment. This was my a bank extends credit, it pretends most observers and indeed many first ‘Green QE’ proposal. Page 3

3

Volume 3, Issue 1 It’s Time for ‘Green QE’… (cont’d from p. 3)

And ‘quantitative easing’ it ronmental sustainability of our penditure. was, as I explain in the box below. economic activity? The govern- It could not lead to inflation, since ment’s Department of Energy Solar PV** without it credit creation was and Climate Change late last In the last year before the gov- shrinking—leading to deflationary year announced that over £200 ernment changed the feed-in pressure. Moreover, inflation is billion worth of energy infra- tariffs, around 150,000 photo not possible if care is taken that structure investment was needed voltaic (PV) systems were fitted QE finances productive invest- within less than 8 years. The on the country’s roofs by an in- ments. Among the most produc- Bank of England could fund those dustry employing around 30,000 tive investments are those in and give Britain a head-start by people, of which about 20,000 human resources, such as univer- implementing some of them in were actual installers. To put sity education and research, and the coming years. solar PV on the three million green, sustainable infrastructure homes best suited to capture the or energy. maximum amount of solar energy The Bank of England has prov- (suitable South-facing roofs), en far less ideological, far more would cost about £15-£20bn at open to rational argument and today's prices. If this was extend- also far quicker in implementing ed to those able to capture ade- new policies than the Japanese quate quantities of energy, i.e. central bank. So it is now time to suitable East and West facing discuss the purchase of other roofs, a further six million homes assets by the Bank of England, not would be involved with the cost just bonds from banks. It is possi- of doing all nine million homes in ble for the Treasury to designate the order of £50-£55 billion. ‘green bonds’ for particular pro- If the Bank of England were to jects. The Bank of England is un- Green QE: Fund £70bn of PV use green quantitative easing to der current laws not allowed to & Energy Efficiency to Cre- pay for these PV installations, the buy them directly however. So ate over 200,000 jobs households involved would save why can the Bank of England not Together with the Green New up to £250 per annum in reduced purchase ‘green’ assets that we all Deal Group we would like to electricity bills, as they benefit agree would not only enhance the propose the following initial from free solar electricity gener- economy but also boost the envi- programme of Green QE ex- ated and earn money for feeding

BOX: Why I Proposed the Concept of ‘Quantitative Easing’ in the 1990s By Richard A. Werner For my media campaign to get the Bank of Japan to abandon its doomed policy of focusing on interest rate reductions—begun in 1991–and to encourage it to increase total credit creation in the system I decided to use a new expression that would avoid the too-technical term ‘credit creation’ (at the time hardly used in Japanese). I was looking for an expression that suggested monetary stimulation, and at the same time made clear at the outset that I was not talking about interest rate reductions, but an increase in the quantity of money circulating. Yet I did not want this policy to get confused with the monetarist prescription to boost the monetary aggregates M0, M1, M3, M4 or the like – all of which I thought would also be doomed (indeed, M0 consists of bank reserves and in the event became the focus of the Bank of Japan and to some extent also the Bank of England; yet ballooning M0 in Japan did nothing to boost broad money supply or bank credit, as I had warned). Hence I chose a combination of the standard expression for ‘expansionary monetary policy’ (which the Japanese refer to as ‘monetary easing’ or only ‘easing’) and the word ‘quantitative’. Thus my original definition of ‘quantitative easing’ was an expansion in broad credit creation, which can be achieved in a variety of ways – I published a major article on this new policy, with ‘quantitative easing’ in the title, in Japan’s main financial daily newspaper, the Nikkei, on 2 September 1995. I assumed that this expression would instantly make it clear that I was not talking about reserve or traditional money supply expansion – why use a new expression for an old policy? Having argued for much of the 1990s that my arguments were wrong, and claiming repeatedly that ‘quantitative easing’ could not work, the Bank of Japan started the second decade of recession by an- nouncing that it was, after all, now going to attempt a policy named ‘quantitative easing’ (retrospectively ** Figures from Solarcentury dating the beginning of the policy to March 2001). But actually all it did was to boost bank reserves. Re- serve expansion is a standard monetarist policy and required no new label. And sure enough, as I had Page 4 warned in the early 1990s, it did not do the economy any good.

4

Volume 3, Issue 1 It’s Time for ‘Green QE’… (cont’d from p. 4) electricity into the grid. ‘fiscal policy’) that would suggest The fact is, the core instru- A 3 million homes pro- it is giving preference to one ment in central banking has for gramme operating at the pace of project over another. centuries been the re- a million properties per year There are two responses to discounting of bills of trade is- being fitted with PV, would likely this: Firstly, if one wishes to, this sued by private sector firms. generate around 140,000 new could still be arranged so that the ‘QE’ the way the Bank of Japan jobs. If that were to be extended Bank of England is purchasing and Bank of England have inter- to all the potential 9 million mere securities. For instance, a preted it were never new poli- homes that could benefit from new entity could be created that cies, since central banks have PV installation, the employment implements the nationwide PV always been engaged in buying growth would be much larger. (and selling) assets – they merely It is possible for the BoE to chose to do this quietly, and do this for free– after all, why without public debate. They have should the BoE charge, since it also always made allocation deci- created the money out of noth- sions in doing so. For instance, ing in the first place? Money crea- for most of their history, central tion is a public privilege. So using banks drew up lists of firms, and it to benefit the public and the maximum amounts allocated to environment seems only right. them, whose bills of trade they would accept. Some firms were Kick-starting the Govern- not chosen. Others received ment’s Green Deal installation programme (and na- large maximum amounts. This “Since central banks On top of funding large-scale tionwide broadband for good always amounted to an allocation solar PV, Green QE could also measure) and owns the assets. It policy. A modern version uses be used to finance the govern- could issue equity, which could be other securities, such as com- make these allocation ment's incoming £16 billion guaranteed against default by the mercial paper (CPs) issued by Green Deal energy efficiency government (at no cost). The firms and various types of bills decisions, why should programme for homes. The gov- Bank of England could then pur- and bonds, which central banks ernment expects this to support chase these securities. (Even the regularly buy (or refuse to, as at least 65,000 jobs in insulation conservative Bank of Japan has the case may be). It is also often there not be a public and construction by 2015. Local taken to buying modest amounts forgotten that central banks authorities, many of whom are of corporate equity, though not create the money they use to already involved in planning to green and not guaranteed against pay for their own salaries, pen- debate about how make tens of thousands more default). sions or purchase recreation local homes energy efficient, It is also possible to do this via facilities (yachts, golf courses, newly created money could access a QE Green Deal a new green fund or bank (such restaurants, etc.). Since they fund to finance such pro- frequently make these allocation grammes. A traditional approach decisions, why should there not from the QE would be for users to pay a small “ is a public also be a public debate about charge. Householders, who how newly created money from would be expected to save more privilege. So using it to ben- the QE programmes is spent for programmes is spent than their repayments, could be efit the public and environ- the public good? charged a low or zero rate of ment seems only right.” for the public good?” interest and would repay over an No Need to Sell Assets Later agreed programme of up to 25 Other critics worry about the years. Once enough of them as a green investment bank) or need to ‘unwind’ QE and how were making these payments, designated ‘green bonds’. But the Bank of England can sell any then these cash flows could be such methods feed more bureau- assets later on. In terms of the securitized into instruments that cracies and fee-charging interme- economics there is no need to could be held by the Bank of diaries, as well as in the case of worry about this: the central England or sold to pension funds. bonds or a bank add to debt and bank can simply keep the assets interest liabilities. on its balance sheet. This is in- Why BoE Independence Secondly, there is strictly deed the most effective way to Would Not be Affected speaking no need to arrange the solve any banking crisis: instead Critics are quick to point out transaction via securities. This of getting the government, and that such proposals are not prac- would save on fees for the ineffi- hence the tax payer, to purchase tical, as the Bank of England wish- cient intermediaries – the securi- non-performing assets or acquire es to purchase ‘neutral’ govern- ties underwriters and brokers. the capital of entire banks, the ment bonds, and does not wish There is no need to create the central bank should do it direct- to be seen to engage in any form incorrect appearance that central ly. As it has the power to create of allocation policy (what central banks do not make allocation money, and as this is just an bankers are quick to label as decisions. Page 5 continued on page 6

5

CBFSD Management School Centre for Banking, Finance and Sustainable Development

The Centre conducts research on the link between the financial sector and economic growth and development. It collaborates with the School of Social Sciences, Division of Eco‐

Centre for Banking, Finance nomics, and is the world’s first research centre to focus on the sustainability aspects of and Sustainable Development banking and development. The Centre was founded by Professor Richard Werner, D.Phil. University of Southampton (Oxon), Chair of Internaonal Banking at the School of Management, in 2008. Management School Building 2 For more informaon about the Centre, please look up www.southampton.ac.uk/cbfsd Highfield Campus or contact Tel: 023 8059 2549 | Email: [email protected] Southampton SO17 1BJ Phone: 023 8059 2549 Fax: 023 8059 3844 E-mail: [email protected] It’s Time for ’Green QE’… (cont’d from p.5) accounting exercise to shore up ernment’s far more expensive tribute to GDP and indeed bank balance sheets, there is no involvement in helping the have been the main reason why need for tax payers to pay or to banks. the banking crisis developed in expand public debt. The assets There are clear advantages of the first place. should simply stay on the cen- a ‘green QE’ policy over alterna- Thirdly, it would ensure tral bank balance sheet. tives. Firstly, it would circum- that the money does not end Sustainable Growth When the Bank of England up in oversized city bonuses. for a Better Future wanted to bail out the bust Fourthly, it would make banking system in August 1914 central bank money injections – bust due to Britain’s declara- more transparent and easier to tion of war on Germany and its understand for the public. www.soton.ac.uk/cbfsd allies, while British banks were Fifthly, it would inject mon- holding vast amounts of their ey in a way that would benefit bills of trade – the Bank of Eng- vent the banking system and the environment and hence land purchased them from the ensure that the newly created would be the most sustainable banks and forgot about them. It money is directly creating new way to boost domestic de- works every time and does not demand in the economy. mand. Finally, it would acceler- cost anything – and thus also Secondly, it would ensure ate the implementation of key does not require the painful that the injected money is not government policies to en- spending cuts that Britain has used for speculative or financial hance the environment and had to endure due to the gov- transactions which do not con- reduce the carbon footprint.

The Green MP and the Green New Deal Group

Caroline Lucas is the MP for Caroline Ms Lucas is member of the Brighton Pavillion and the leader Lucas, Green New Deal Group, along of the Green Party of England Green with Larry Elliott, Colin Hines, and Wales. In 1999, she was Party Tony Juniper, Jeremy Leggett, elected as one of the Party’s MP Richard Murphy, Ann Pettifor, first MEPs and represented the Susie Parsons, Ruth Potts and South East until 2010, when she Observ- Andrew Simms as members. became the UK’s first Green er, The Green New Deal MP. awarded Group has called for the alloca- Caroline is a Co-Chair of ‘New- tion of large-scale capital to the All Party Parliamentary comer of reduce carbon and increase Group on Fuel Poverty and the Year energy security. *References: Energy Efficiency and a member 2010’ in It has proposed to expand Ryan-Collins, Greenham, Werner of the Environmental Audit the Spectator Parliamentarian the BoE’s operations to include & Jackson (2011), Where does Money Come From?, new econom- Committee. She has been voted awards, and named ‘Most Influ- green investments. ics foundation the UK’s most ethical politician ential MP of the Year 2011’ by

Richard A. Werner (2005), New three times by readers of the the Political Studies Association. (www.greennewdealgroup.org) Paradigm in Macroeconomics, Palgrave Macmillan

6