Gareth Vaughan on QE vs monetary financing, COVID-19 housing opportunities, crowdsourcing low interest rate advice, how a computer language controls the financial life of the world, strangled by conservative credentialism & Project Helvetia

Gareth Vaughan on QE vs monetary financing, COVID-19 housing opportunities, crowdsourcing low interest rate advice, how a computer language controls the financial life of the world, strangled by conservative credentialism & Project Helvetia

This Top 5 comes from's Gareth Vaughan.

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The end of this extraordinary year is nigh and there's still plenty of interesting news and analysis around. Some of it is below.

1) Quantitative easing versus monetary financing.

In a wide ranging speech last week Reserve Bank Governor Adrian Orr explained the reasoning behind the quantitative easing initiative the central bank launched earlier this year in the wake of COVID-19. He also contrasted this with the concept of the Reserve Bank directly financing the Government, noting this is outside its mandate.

Monetary financing, by contrast, occurs when government spending is financed by a central bank being instructed to issue irredeemable fiat non-interest bearing liabilities to the Government. This activity sits outside of the Reserve Bank’s mandate and is unrelated to the Bank’s inflation and employment remit.

There has been quite a bit of discussion and debate this year about the Reserve Bank potentially directly funding government stimulus in the age of COVID, especially given the way QE helps inflate housing and share market values without necessarily assisting non-asset owners. For example, former investment banker and ex-Christchurch City Councillor Raf Manji advocated for direct funding in this interview.

Orr's comments come after a Treasury and Reserve Bank paper prepared for Finance Minister Grant Robertson dating from May, comparing quantitative easing (QE) and monetary financing (MF), recently emerged courtesy of the Official Information Act.

It starts by setting out the differences.

QE involves purchases of government bonds and other financial assets, usually in the secondary market (but potentially in the primary market) to reduce market interest rates. As a by-product, QE also assists the government to meet its funding needs over the short- to medium-term.

QE is a temporary measure when interest rates are at the ELB [interest rate effective lower bound] and/or in the event of an economic shock. Central Banks aim to stop bond purchases when economic conditions improve but typically hold bonds until they mature.

MF involves financing a fiscal deficit not by the issue of interest-bearing debt, but by an increase in the monetary base – i.e. of the irredeemable fiat non-interest-bearing monetary liabilities of the government/central bank. 

This means fiscal spending is funded by a permanent increase in the monetary base.

The paper also features a section on risks and some mitigation measures of going down the monetary financing path. I sense this would've been more than enough to put an inherently conservative politician like Robertson off the idea, even if he had been open to considering it.

Internationally, over the past 30 years it has become common practice to have an operationally independent central bank with an inflation target, and government subject to fiscal disciplines. MF would require the design of a new institutional framework. This justifies consideration of the risks, and how to mitigate and manage those risks.


The influence of fiscal over monetary policy – actual or perceived – is inherent in the value proposition of MF, and therefore creates risks. For example, if MF is perceived as representing a loss of fiscal discipline and abandoning of mainstream monetary policy, the impact is highly uncertain but could lead to rising inflation expectations, an erosion of trust in economic institutions, and/or a downgrade in credit ratings. Any of these outcomes would see New Zealand’s country risk-premium rise, potentially overriding the real economy intent of the original policy choice.

Risk Mitigation

A key mitigating factor for anchoring perceptions of MF could be the decision-making and governance arrangements that surround it. Arrangements that resemble existing monetary policy decision-making settings i.e. operational independence for monetary policy, could reassure that MF is not a ‘complete break’ from existing ‘norms’. Other characteristics may also contribute to reducing perception risks, such as being subject to activation triggers (e.g. very low inflation, very high debt to GDP), being ‘one-off’, and/or attached to a specific event or purpose.

Officials can provide you with further information about these issues if you wish.

2) World’s biggest pension fund crowdsources advice on how to deal with low interest rates.

In a sign of the times, Japan's Government Pension Investment Fund, which manages US$1.6 trillion in assets, put out a request for information seeking explanations as to what has caused the entrenched global zero-interest rate environment, Bloomberg reports. It's interesting and concerning that those in the country that has had low rates for longer than the rest of us want help...Any suggestions?

The fund is itself one of the world’s key buyers of bonds, and as the steward of Japan’s pension system is well used to a world in which much of its portfolio sees low returns -- GPIF kept well over half its assets in low-yielding Japanese bonds until as recently as 2014.

As part of a search for yield to support the nation’s rapidly aging population, the GPIF this March raised its portfolio allocation of foreign bonds by 10 percentage points -- just as global yields plunged to join Japan’s almost-perpetually low-returning debt.

The GPIF suggested that experts in Modern Monetary Theory might be called upon to explain the global phenomenon, and is also seeking help on how it should estimate its bond returns in such a world.

3) Housing opportunities created by COVID-19.

It's years since I went to Lisbon but I enjoyed my visit and have fond memories of Portugal. As concerns mount once again over the housing situation in New Zealand, this Guardian story, looking at how cities overseas are using opportunities created by the COVID-19 pandemic to tackle housing issues, caught my eye. It starts off in Lisbon, and takes in initiatives in England, Venice, Vancouver, California, Barcelona, Amsterdam and the Czech Republic. 

In Lisbon they found themselves with a swathe of Airbnb-style tourist rentals no longer needed by tourists as tourism dried up.

“In a certain sense Covid has created an opportunity,” Fernando Medina, the mayor of Lisbon, told the Guardian. “The virus didn’t ask us for permission to come in, but we have the ability to use this time to think and to see how we can move in a direction to correct things and put them on the right track.”

The city seized on the moment to cast new light on a programme that was in the works prior to the pandemic: an ambitious plan to convert some of the city’s more than 20,000 tourist flats into affordable housing.

The initiative, billed by the city as a “risk-free” option, offers landlords the possibility of receiving up to €1,000 a month by renting their properties to the city for a minimum of five years. From there the city takes over, finding tenants and renting the homes at a subsidised rate capped at a third of the household’s net income.

For landlords, the rental income is likely to be lower than what they might earn from tourists down the road. But the city is betting that the long-term, stable income – and the offer to pay an advance of as much as three years’ rent – will win over landlords as they grapple with the uncertainty generated by the pandemic.

4) How a computer language controls the financial life of the world.

This Clive Thompson article in Wealthsimple Magazine delves into the ongoing influence and importance of COBOL, or Common Business-Oriented Language. Thompson writes about how this decades old computer language still dominates within the global banking system. The article features "Thomas," who learned about COBOL in 1969 and is still in demand from one large bank today, because of his COBOL knowledge, even though he's 73 and has been retired for several years.

In fact, these days, when the phone rings in the house Thomas retired to — in a small town outside of Toronto — it will occasionally be someone from the bank. Hey, they’ll say, can you, uh, help… update your code? Maybe add some new features to it? Because, as it turns out, the bank no longer employs anyone who understands COBOL as well as Thomas does, who can dive in and tweak it to perform a new task. Nearly all the COBOL veterans, the punch-card jockeys who built the bank’s crucial systems way back when, who know COBOL inside and out — they’ve retired. They’ve left the building, just like Thomas. And few young coders have any interest in learning a dusty, 50-year-old computer language. They’re much more excited by buzzier new fields, like Toronto’s booming artificial-intelligence scene. They’re learning fresh new coding languages.

So this large bank is still dependent on people like, Thomas, who is 73, to not only keep things running, but add new features and improvements.

Will his COBOL outlive him?


That bank is not alone. COBOL programs — some written so long ago that color TV wasn’t even a thing yet — are everywhere in our daily lives.

Consider: Over 80% of in-person transactions at U.S. financial institutions use COBOL. Fully 95% of the time you swipe your bank card, there’s COBOL running somewhere in the background. The Bank of New York Mellon in 2012 found it had 112,500 individual COBOL programs, constituting almost 350 million lines; that is probably typical for most big financial institutions. When your boss hands you your paycheck, odds are it was calculated using COBOL. If you invest, your stock trades run on it too. So does health care: Insurance companies in the U.S. use “adjudication engines'”— software that figures out what a doctor or drug company will get paid for a service — which were written in COBOL. Wonder why, when you’re shopping at a retailer you will see a clerk typing into an old-style terminal, with green text on a black background? It's because the inventory system is using COBOL. Or why you see airline booking agents use that same black screen with green type to change your flight? “Oh, that’s COBOL — that’s definitely COBOL,” laughs Craig Bailey, a senior engineer at Faircom, a firm that makes software to help firms manage those old systems.

No one quite knows how much COBOL is out there, but estimates suggest there are as many as 240 billion lines of the code quietly powering many of the most crucial parts of our everyday lives. “The second most valuable asset in the United States — after oil — is the 240 billion lines of COBOL,” says Philip Teplitzky, who’s slung COBOL for decades for banks across the U.S.

I'm not sure to what extend New Zealand banks use COBOL. But would be interested to hear.

5) A discipline that has been strangled by conservative credentialism.

This Current Affairs article, Abolishing the Economics Nobel Isn’t Enough, delves into battles over the awarding of the Economics Nobel Prize. The broader question raised of how and why economists have so much influence is what caught my eye.

But this just begs the question (and yes, internet pedants: that is the proper usage of the phrase) of why economists are the ones who get to work out all these problems without including citizens or citizens’ representatives. If the application of economic models to policy throws up the same challenges that democracy was intended to solve—that is, balancing a whole set of competing considerations, and making a lot of mistakes while doing so—why move away from democracy in the first place? And if many economists do not know much of the work and how it’s been used, what hope does your average citizen have?

The classical answer to all this is that economic expertise (as with medical expertise) allows us to pursue some “good” which would be unattainable in its absence. But this does not answer the question of who gets to choose which “good” is being pursued. Nor does it address whether economists truly have this exclusive claim to knowledge, or who will hold them accountable if they mess up. Medicine has its issues, of course, but there is a strong code of ethics, and doctors are not typically put in charge of healthcare policy. By contrast, economists have no professional standards or ethical code, and they’re recruited to help shape almost every area of public policy, as well as the private sector. The lack of critical introspection by the discipline does not help here. While anthropologists, for example, tie themselves in knots over whether their entire discipline is just a vestige of colonialism, economists have a hard time conceiving of themselves as doing anything other than good.

5+1) Central bank digital currency and Project Helvetia.

The Bank for International Settlements (BIS), the central banks' bank, is trumpeting a successful wholesale central bank digital currency (CBDC) experiment.

BIS says Project Helvetia shows the feasibility of two proofs of concept, using "near-live" systems to settle digital assets on a distributed ledger with central bank money. It involved comparing a proof of concept linking the existing payment system to a distributed ledger and another issuing a wholesale central bank digital currency. BIS says Project Helvetia sets the scene for further joint experimentation to assess the impact of digital innovation on the future of the financial system.

The initiative demonstrated the feasibility and legal robustness of both alternatives in a near-live setup.

However, comparing them reveals benefits and challenges. A wholesale CBDC has potential advantages when settling digital assets. Yet it would raise major policy and governance hurdles. Linking existing systems to new DLT [distributed ledger technology] platforms would avoid many of these problems, but would forgo the potential benefits of full integration. Project Helvetia explored a wholesale CBDC, restricted to banks and other financial institutions. A retail or general purpose CBDC would address different use cases and have very different policy implications.

The proofs of concept are experiments conducted at the BISIH [The Bank for International Settlements' Innovation Hub] and should not be interpreted as an indication that the SNB [Swiss National Bank] is to issue wholesale CBDCs onto SIX Digital Exchange's (SDX) platform or to allow settlement of SDX transactions in the Swiss Interbank Clearing system.


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#2 - I could tell them.

#5 - Good start to the conversation. But it's not just Economics; when you scratch academia, the silo-effect is a big Achilles Heel. They genuflect but fail to mesh.

I'd throw the same criticism at three Climate-related academics this morning:
Did they ask about overshoot? About depletion? Remaining sink capacity other than atmosphere/CO2? Nope. But they feel quite qualified to advocate kicking the can......

€1000/month rent is actually very high for Europe. In Germany you would expect to pay a half to a third that. That said, I appreciate the weather is better in Portugal.

RE:1) Quantitative easing versus monetary financing.

Back to what Kelton said; base money. Among the fatal conceits MMT shares with neo-Keynesianism – as dutifully practiced in Japan all these years – is this self-imposed monetary blindness. They all assume bank reserves are base money when it is demonstrated worldwide that the modern reserve currency system has operated for more than half a century way, way outside the presumed government monopoly.

Eurodollar today means private, bank-centered money. A system that had little use for the government and Fed’s form of bank reserves, a fact which didn’t change, obviously, with the explosion of them post-2008.

Like MMT, Keyensians are adherents to the closed-system approach, what I like to call bathtubbers. They equate the domestic economy to a bathtub where the faucet is the only way in which water (money) may enter. It is merely assumed that cross-border links outside of specifically merchandise trade balances (current account) are relatively minor and in the end unimportant.

MMT dumps different color water into the same bathtub full of holes Ben Bernanke didn’t know were there, expecting the water color to be the difference also unaware of the holes.

None of them make room in their theories for something like a eurodollar system; they are unaware they need to factor for a true global currency and the system for it the size of which dwarfs (quantitatively, as well as qualitatively) their domestic money assumptions. In making no room for eurodollars in their theories, they make no room for real world practice, sharing the same with central bankers and neo-Keynesians (same thing).

Neither Kelton nor Wray (or any others) have said (that I know of) how their charta would either replace the eurodollar or successfully compete with it so as to either way remove the sources of deflation obviously stifling the real-world global economy. The fact it never comes up is all you need to know; MMT, at root, believes there is only one dollar which the government controls.

In other words, it proposes to supplant central bank monetary ignorance of the sources of these economic and more so monetary imbalances with Treasury Department monetary ignorance of the exact same. The descriptions of how Treasury pays its bills and uses the Fed are indeed accurate, but ultimately meaningless apart from this trivia. Link

Demand for dollars via FX swaps
Aggregate data on the use FX swaps and FX forwards can be obtained from the BIS derivatives statistics.2 The BIS OTC derivatives data (OTC data) show that the total amount outstanding at end-June 2019 neared $86 trillion (Graph 2, first panel), with FX swaps accounting for an estimated three quarters of this total. Link

• At $13 trillion, the gross dollar liabilities of banks headquartered outside the United States at end-2019 were nearly as high as before the Great Financial Crisis. Most of their dollar funding was booked outside the United States.

• We measure non-US banks’ short-term dollar funding needs by comparing short-term dollar liabilities (including off-balance sheet FX swaps) with holdings of liquid dollar assets.

• The scale of the central bank swap lines are of similar magnitude to banks’ short-term dollar funding needs. Swap line usage peaked in May at $449 billion and has subsided since. However, dollar funding needs of corporates may yet reveal a broader need for dollars outside the banking system. Link

There is quite a good deficit & MMT discussion here -

Banks don't create currency though as your article describes, they can only create credit money with a debt liability attached and with an added interest charge and we can see with the GFC where this type of money creation takes us to. Only the government can create currency which is free of debt for us to use and to save. NZ has one of the highest levels of household debt along with low levels of savings and high house prices all due to monetary policy having precedence over fiscal policy.
MMT does indeed recognize the external balance as one of the three financial flows into the economy, the banks and the government being the other two. The sectoral balance identity is expressed thus (S-I)=(G-T)+(X-M) . X being exports and M being imports.

#1 There are a couple of things that I don't understand about the RBNZ and Orr; at the end of 2019 they were telling us they had stress tested the banks and were confident that they could withstand as much as a 50% fall in house prices. Now they are running scared and seem to be saying no fall is acceptable!!!!?

#4 i wonder how much processing power COBOL uses v one of the newer languages? Surely there would be efficiency gains to be had by rewriting the software?

I believe NZ Government (MSD) transfer payments software is COBOL based.

Not necessarily much performance gain from a modern language, depending on how the original is implemented. The biggest advantage would be in being able to find people to maintain it! Though this sort of story certainly isn't new, so I suspect there are a few people who have spotted an opportunity and decided to brush up their cobol and fortran.

The banks will survive the 50% fall in house prices. The people of New Zealand will likely be looking to develop something similar to the guillotine for their elected representatives. Arden is a big fan of keeping her head on her shoulders hence the no fall is acceptable position.

I had to smile at that response Sadr! I think you're probably right.

#4 COBOL is a compiled language. The compilers have to be able to use the raw instruction sets of the specific hardware and OS combination the compiled code runs on. So there will be continued development in compilers but not necessarily in the COBOL itself. COBOL is like Latin - a relatively unchanging relic - which actually confers enormous advantages in that coders don't have to keep up-to-date with the latest brain-farts from the languages other poor sods have to use. And as to performance, well, nothing runs faster than compiled code....

COBOL has been like that for years, I had the same conversation with a COBOL programmer while working for a bank over a decade ago. It's nothing new, but the problem becomes more and more urgent as time goes on.

"QE is a temporary measure when interest rates are at the ELB [interest rate effective lower bound] and/or in the event of an economic shock" - hilarious. Please tell all the Central banks of the world who have been doing it for a decade or two that its "temporary".

I wonder if these institutions using COBOL have carried out server hardware refreshes over the years or are still running it on old hardware.

Nice piece.
Re housing approach in Lisbon, nothing like that will ever be contemplated here because we remain wedded to neoliberalism and the 'free market' whether we have a centrist blue team or a centrist red team.

Cobol. Classic Dilbertian business practice. Get rid of the knowledgeable people, and refuse to train people to operate the computer language the bank uses. The problem is literally this refusal. If offered training in Cobol, with the correct financial incentive, for example, about 10% of the chief executive's pay, people would queue up out the door to train in Cobol. This story is either total rubbish, or an accurate reflection of the incompetent, dysfunctional buffoons I have had personal experience of running banks.