Monday's Macro Memo: A UK Sovereign Wealth Fund
In a recent piece in the Financial Times, Tristan Hansen and Eric Lonergan make the case for the U.K. government to “think big and tap the bond markets to invest in a bold growth agenda for the UK economy”. They go on to argue that “A sovereign wealth fund, [SWF] 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.”
In a series of published scholarly papers, books and op eds dating back ten 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 SWF as a strong form of qualitative easing that should be used to stabilize inefficient asset price swings. I’m less clear about the objective of the Hansen-Lonergan plan.
Here is how I put it in my latest 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, Prosperity for All, Pages 206—207]
In 2013, I testified to the UK Treasury Select Committee, urging the UK to adopt an active financial stabilization 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 (MPC) 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 FPC in the UK would be an ideal body to carry out this task.
If an FPC 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 FPC 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 FPC should target the unemployment rate….[Farmer, Prosperity for All. Page 194]
I have long recommended that a SWF 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 FPC would be charged with trading the index fund countercyclically. When unemployment is deemed to be about right, the FPC would announce a growth path for the index fund that is coordinated with the MPC 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 FPC would trade shares to support a growth rate of the stock market that is higher than Bank Rate. If the unemployment rate moves below target, the FPC would trade shares to support a growth rate of the stock market that is lower than 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 Hansen and Lonergan see as the purpose of a SWF?
“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.”
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.
Myself, Miles, 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 SWF 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 stabilizing asset price movements. If you learn something from these pieces, please cite them when discussing the ideas.
Farmer, Roger E. A., “What Keynes Should Have Said”, VoxEU February 4th 2009
Farmer, Roger E. A. “Macroeconomics for the 21st Century: Part 2, Policy”, VoxEU February 28th 2010
Farmer, Roger E. A. How the Economy Works, Oxford University Press, 2010
Farmer, Roger E. A., Macroeconomics for the 21st Century: Full Employment as a Policy Goal. National Institute Economic Review, 211(January), pages R45-2R50, 2010
Farmer, Roger E. A. How to Reduce Unemployment: A New Policy Proposal. Journal of Monetary Economics: Carnegie Rochester Conference Issue, 57(5) 2010
Kimball, Miles, “Why the U.S. Needs its own Sovereign Wealth Fund” Quartz January 3rd 2013.
Kimball, Miles, “Libertarianism, a US Sovereign Wealth Fund, and I” Confessions of a Supply Side Liberal, January 23rd 2013
Kimball, Miles, “How a US Sovereign Wealth Fund can Alleviate a Scarcity of Safe Assets”, Confessions of a Supply Side Liberal January 25th 2013
Farmer, Roger E. A. “Quantitative Easing”, Written Evidence to the Treasury Committee of the U.K. Parliament, Session 2102-13. Oral evidence presented, 24th April 2013
Farmer, Roger E. A. “Qualitative easing: a new tool for the stabilisation of financial markets: The John Flemming Memorial Lecture. Bank of England Quarterly Bulletin,” December Q4, pages 405-413, 2013
Kimball, Miles, “Roger Farmer and Miles Kimball on the Value of Sovereign Wealth Funds for Economic Stabilization”. Confessions of a Supply-Side Liberal, January 8th 2014
Farmer, Roger E. A. “Financial Stability and the Role of the Financial Policy Committee.” The Manchester School, 82 S1, pages 35-43, 2014
Farmer, Roger E. A., Prosperity for All, Oxford University Press, 2016.