Monetary policy still works at the ZLB

In case anybody was wondering, monetary policy definitely still has an effect at the zero lower bound.  In the UK, the banks have unwittingly (and certainly unwillingly) been part of a demonstration of a so-called helicopter-drop of money.  In a country of 60 million people, by mid 2008 there were over 20 million Payment Production Insurance (PPI) policies in effect and that number was growing fast.  In early 2011, they were ruled to have been mis-sold (customers were deemed, in general, to have been pressured or deceived into buying insurance they didn’t need) and banks were ordered to offer compensation.  Wikipedia has a summary here. From a pair of articles in the FT ([1], [2]):

[Article 1] About £4.8bn had already been paid out by the end of May – effectively acting as “helicopter money” dropped into the hands of those people who may be among the most likely to spend it.

[Article 2] The independent Office for Budget Responsibility, relying on estimates that PPI refunds would deliver £6bn over the year, revised up its estimate of the growth rate of real disposable household income by 0.5 percentage points in March from its November figure … the amounts set aside for PPI redress by the five biggest banks have now soared to almost £9bn.

[Article 2] The FSA said it does not know the average payout per claimant. But some of the “complaints management” companies, which have been making aggressive pitches to help consumers get their money back, say these average £2,000 to £3,000 per applicant.

[Article 1] “When I heard I was going to get over £2,000 in compensation I hired builders to fix a long-overdue problem with the eaves in my roof and put the rest of the money towards a holiday to Greece in September,” said Elaine Overten, a retired nurse from Derbyshire, who received compensation for PPI payments made on her NatWest mortgage over 10 years.

I just love the little (and not remotely subtle) hint from the FT that monetary stimulus would help Greece out of their hole.

Anyway, the point is simple.  If you put money in people’s hands, especially if those people are “credit constrained,” they will spend it.  That was the point of my “Monetary policy for 10 year olds” post a while ago.  It remains the point today.  It will always be the point.

The problem, of course, is that while PPI compensation payouts are acting as a positive stimulus, the corresponding hit to the banks will be causing them to hold back in their lending and so provide a negative stimulus at the same time.  If I had to guess, I’d say that the net effect of PPI compensation is to provide a positive stimulus because of the broad distribution and, I assume, the fact that a large fraction of the recipients really are currently credit constrained.

4 Responses to “Monetary policy still works at the ZLB”


  • Are you not also missing the opportunity cost of the mis-sold PPI insurance removing wealth from the UK economy in prior years? In the case of Elaine, she quite likely might have had to spend less on her house value improvement/repair project at an earlier date thus limiting the damage earlier, and spent GBP that previously had more buying power due to the subsequent inflation the UK has experienced in the last 10 years.

  • Yes and no. You’re right in that by having less money in her pocket back then Elaine would have put off house repairs and holidays. But back then the banks were operating properly [*], too. The money Elaine didn’t have was money they did have, and so would have been used to fund further lending. This is just the reverse of the comment I made in my last paragraph.

    Note, too, that if you were to offer a central banker an opportunity to hold down economic activity during a boom that would also serve to stimulate activity during the next slump, they’d jump at the opportunity. 🙂

    [*] I mean “operating properly” in the sense of extending loans *at all*, not in the sense that I approve of the apparently innumerable cases of ridiculously risky and implicitly-taxpayer-guaranteed behaviour they engaged in at the same time.

    • Good point. It is of course hard to determine whether the loss of value in capital investment she had to delay was more or less than the possible investment value lending the money the banks gained my mis-selling her PPI.

      However, as demonstrated by the financial events of 2008, Elaine (and the other PPI claim recipients) are likely a more efficient market participants than the too-big-to-fail banks on a per GBP investment basis. It is my understanding that labour and capital investment is generally more likely to increase GDP than adding more debt. I guess we’ll find out, given that this is broadly the same experiment the governments of the USA, UK and Europe are attempting. Reinhart and Rogoff indicate that the experiment has failed historically once debt levels are over 90% of GDP (http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf)

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