First posted on:
Roger Farmer's Economic Window, 17 December 2017
In a Financial Times piece dated 23 November 2017, Tristan Hanson and Eric Lonergan made the case for the UK government to “think big and tap the bond markets to invest in a bold growth agenda for the UK economy”. They went on to argue that:
A sovereign wealth fund, tasked with boosting socially useful investment in the UK economy from inadequate levels could be the answer. … Increasing investment through a sovereign wealth fund can be used to tackle deficiencies in housing, infrastructure, as well as support innovation and small businesses. It will create productive assets from which future generations will benefit. (Hanson and Lonergan 2017).
In a series of published scholarly papers, books and op-eds dating back 10 years or more, I have been making the case for an asset fund, backed by bond purchases. And I have provided the economic theory to explain what such a fund would do, and why we need it. Miles Kimball first called this a sovereign wealth fund and he explains the case rather nicely here. I see a sovereign wealth fund as a strong form of qualitative easing that should be used to stabilise inefficient asset price swings. I’m less clear about the objective of the Hanson-Lonergan plan.
Here is how I put it in my book, Prosperity for All:
When the Fed was created in 1913, central bank intervention in the financial markets to control a short-term interest rate was considered to be a radical step. A century later, we have learned that interest rate control is an effective way to maintain price stability, but we have not yet learned how to prevent financial crises. Modern policymakers have been assigned one instrument—control of the money interest rate—and two targets: low inflation and full employment. A single instrument is not sufficient to accomplish both tasks.
Asset market fluctuations are not caused by inevitable fluctuations in productive capacity. They are caused by the animal spirits of human beings. The remedy is to design an institution, modeled on the modern central bank, with both the authority and the tools to stabilize aggregate fluctuations in the stock market.
Since the inception of central banking during the seventeenth century, it has taken us 350 years to evolve institutions to manage prices. The path has not been easy and we have made many missteps. Let us hope the adoption of a new financial policy that can prevent and/or mitigate the effects of financial crises on persistent and long-term unemployment will be a much swifter process than the 350 years it took to develop the modern central bank. (Farmer 2016: 206-207)
In 2013, I testified to the UK Treasury Select Committee, urging the UK to adopt an active financial stabilisation policy, and, in an academic article in 2014, I explained how this would work. I argued there that an entity like the Monetary Policy Committee of the Bank of England, perhaps attached to the Bank or perhaps an independent body, should be charged with the operation of a fund that purchases risky assets paid for by issuing Treasury debt. The existing Financial Policy Committee in the UK would be an ideal body to carry out this task.
If [a financial policy committee] were to be created in a sovereign state, modeled on the UK Financial Policy Committee, what should be its mandate? There are two possible answers to this question. The first is that the [financial policy committee] should be concerned solely with financial stability and should target the price-to-earnings ratio of the ETF. The second, and one that I favor, is that the [financial policy committee] should target the unemployment rate…. (Farmer 2016: 194)
I have long recommended that a sovereign wealth fund should consist of a value weighted index fund defined over all publicly traded stocks. In my view, the purpose of such a fund would be to act as a stability mechanism for the asset markets. The financial policy committee would be charged with trading the index fund counter-cyclically. When unemployment is deemed to be about right, the financial policy committee would announce a growth path for the index fund that is coordinated with the Monetary Policy Committee interest rate decision. For example, if the bank rate is 3%, the fund would grow at 3%.
If the unemployment rate moves above target, the financial policy committee would trade shares to support a growth rate of the stock market that is higher than the bank rate. If the unemployment rate moves below target, the financial policy committee would trade shares to support a growth rate of the stock market that is lower than the bank rate. My books and articles explain the economics behind this plan. The asset markets are inefficient and excessively volatile, and asset price fluctuations are translated into inefficient swings in the unemployment rate.
What do Hanson and Lonergan see as the purpose of a sovereign wealth fund?
We advocate a sovereign wealth fund as the vehicle for boosting UK investment since such an entity explicitly recognises public assets, while, in the absence of such a fund, boosting investment in the economy has been proven difficult. Adopting a diversified investment approach is also preferable to the standard prescription of large-scale infrastructure projects, given how long it can take for the benefits of [the] latter to be realised. (Hanson and Lonergan 2017)
There seem to be as many visions of a sovereign wealth fund as people who have written about it. But a bond-financed investment strategy in housing, infrastructure, and small businesses is not a sovereign wealth fund. It is an industrial policy. Issuing bonds and purchasing the stock market does not provide an incentive to anyone to invest in tangible capital investments. It is not enough to simply buy stocks and shares. The purpose must be to target the prices of those stocks and shares and, in my view, to reduce excess asset price volatility and alleviate and or prevent future financial crises.
Miles and I and Tristan and Eric agree that national treasuries can borrow very cheaply and that national governments have the potential to generate substantial revenues by issuing debt and investing in the stock market. Tristan and Eric want to use borrowed funds to invest in specific projects although they are not particularly clear about how that would work. Miles and I want to see a sovereign wealth fund used to stabilize bubbles and crashes in asset markets and, for us, a UK sovereign wealth fund offers a promising alternative to traditional fiscal policy that deserves to be seriously considered before the next major financial crisis hits.
Here is some background reading for those who would follow the genesis of the idea of creating a sovereign wealth fund with the goal of stabilising asset price movements. If you learn something from these pieces, please cite them when discussing the ideas.
Farmer, Roger EA (2009), “What Keynes Should Have Said”, VoxEU.org, 4 February.
Farmer, Roger EA (2010), “Macroeconomics for the 21st Century: Part 2, Policy”, VoxEU.org, 28 February.
Farmer, Roger EA (2010), How the Economy Works, Oxford University Press.
Farmer, Roger EA (2010), “Macroeconomics for the 21st Century: Full Employment as a Policy Goal”, National Institute Economic Review 211(January): R45-2R50.
Farmer, Roger EA (2010), “How to Reduce Unemployment: A New Policy Proposal”, Journal of Monetary Economics: Carnegie Rochester Conference Issue 57(5).
Kimball, Miles (2013), “Why the U.S. Needs its own Sovereign Wealth Fund”, Quartz, 3 January.
Kimball, Miles (2013), “Libertarianism, a US Sovereign Wealth Fund, and I”, Confessions of a Supply Side Liberal, 23 January.
Kimball, Miles (2013), “How a US Sovereign Wealth Fund can Alleviate a Scarcity of Safe Assets”, Confessions of a Supply Side Liberal, 25 January.
Farmer, Roger EA (2013), “Quantitative Easing”, Written Evidence to the Treasury Committee of the UK Parliament, Session 2102-13, oral evidence presented, 24 April.
Farmer, Roger EA (2013), “Qualitative easing: a new tool for the stabilisation of financial markets: The John Flemming Memorial Lecture”, Bank of England Quarterly Bulletin December Q4: 405-413.
Kimball, Miles (2014), “Roger Farmer and Miles Kimball on the Value of Sovereign Wealth Funds for Economic Stabilization”, Confessions of a Supply-Side Liberal, 8 January.
Farmer, Roger EA (2014), “Financial Stability and the Role of the Financial Policy Committee”, The Manchester School, 82 S1: 35-43.
Farmer, Roger EA (2016), Prosperity for All, Oxford University Press.