Thursday, 4 February 2010

Quantitative easing bed time stories.

Once upon a time there was a cafe owner who had one of those orange squash dispensers where the squash is contained in a transparent tank – so customers can see the orange squash.

Orange squash sales were not doing too well. So the cafe owner had a bright idea. Since the squash tank was only half full, the cafe owner figured that if he put more squash in the tank, people would buy more squash.

So he topped the tank up. And what do you know? People DIDN’T buy more squash.

Second story.

Once upon a time there were some central bankers who wanted to stimulate their economies. So they reduced interest rates to near zero. But the effect was not sufficient. So they printed loads of extra money and gave it to commercial banks. Or rather, they gave it to commercial banks in exchange for securities. And, most important of all, they gave the process an important sounding name: “quantitative easing”. (Incompetence or skullduggery can always be disguised if you give them an important technical sounding name: “weapons of mass destruction” springs to mind.)

Anyway these silly central bankers thought that giving banks lorry loads of cash, for some bizarre reason, would result in increased orders for the output of local engineering firms, house builders etc.

Well it didn’t work too well. Banks just kept the money and did nothing with it. In fact the banks’ reserves shot up at an all time record rate. Piles of money doing nothing. Piles of orange squash doing nothing. (See extreme right of chart, and notice the extent of the excess reserves: about one trillion dollars.)

So what’s the solution, children? The solution is give the additional money to the cafe’s CUSTOMERS – or more to be more accurate, consumers in general. The latter would then buy more stuff from the cafe (and from other businesses). This would induce the cafe owner to hire more staff, thus reducing local unemployment. Plus the cafe owner (and other businesses) would run along to the local bank asking for loans to expand said businesses.

The payroll tax holiday long advocated by Warren Mosler would more or less fit the bill: feeding stimulus direct to consumers.

Feeding stimulus direct to consumers makes sense, first, because consumers are the source of all domestic private sector demand. Secondly this policy is not DIRECTIONAL. That is, it does not boost one or relatively few sectors of the economy: making borrowing easy or cheap boosts just those sectors of the economy that borrow significant sums: e.g. people buying houses.

And to make stimulus even more non-directional, government spending needs to be boosted by about the same amount as consumer spending.

Footnote: some interesting stuff on stimulus, banks, etc.

First, a study from Manchester University giving amongst other things figures for bailout costs per person in the UK: see p.33.

Second, some pie charts giving an idea of the total amounts devoted to stimulus in different countries, and the proportion of this going to banks.

I came across the above two items on Bill Mitchell’s site.

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