Friday, 28 June 2013

Not only is QE nonsense: so is the rest of monetary policy.

One of the main excuses for QE is that things would have been worse without it, which is a bit like saying that on a cold day it’s an idea to burn your furniture on your log fire. After all, the house would be “colder without” burning your furniture.

The latter furniture burning policy of course begs the question as to whether there isn’t a better way warming your house. Likewise, the above QE argument begs the question as to whether fiscal stimulus ins’t better than QE.

Amazing the daft logic employed by Bank of England officials and other members of our elite, ins’t it?

Anyway, QE has been widely ridiculed elsewhere so I won’t say any more about it. Instead, let’s consider the other main element in monetary policy, namely interest rate adjustments.

Recessions have several different possible causes. Let’s take each in turn and see if an interest rate cut makes sense.

A recession could be caused by employers deciding that less investment will be needed in future. I.e. a recession can be caused by a fall in investment spending. If there really is a drop in the total amount of investment needed, then an interest rate cut is not appropriate. I.e. what’s the point in encouraging investment, when less investment is needed?

The best policy is simply to boost consumer spending.

Alternatively, employers might cut investment spending because they think consumer demand in on the wane. In that case the best solution is to make sure consumer demand does not wane!!!

Also, if interest rates are cut in either of the above scenarios, that will boost consumer spending, but it will skew the spending towards durables - a “skew” that will have to be unwound later. So that doesn’t make much sense. And the “skew” is substantial: that is, interest rate cuts have a big effect on demand for durables compared to other forms of consumer goods: see here.


A possible argument for monetary policy is the lags are shorter than in the case of fiscal policy, but there does not seem to be much evidence in support of that idea.

A rise in consumer caution.

Another possible cause of recessions is consumers abandoning “irrational exuberance” mode, and moving towards “savings” mode.
An interest rate cut would help there, but it involves the above mentioned “skew”.

And if the root cause of the problem is people’s decision spend less: i.e. their decision to build up their cash holdings (Keynes’s paradox of thrift unemployment) why not supply them with more cash?  In MMT parlance, if people’s “savings desires” are not being met, supply them with savings.

If government goes for the “create money and spend more” option, that has an instant fiscal effect: jobs are created. If government goes for the “tax less” option, that also increases household’s stocks of cash. Plus if households see their cash holdings rising towards their desired level, they’ll probably increase their spending immediately to some extent: i.e. they won’t wait till their “net financial assets” have reached the desired level before increasing their spending.

Creating new money and spending it into the economy is really a mix of monetary and fiscal policy. And it’s a policy often promoted by advocates of full reserve banking, e.g. this lot.  But it’s certainly not an interest rate cut – though doubtless there will be a finite effect on interest rates.

Conclusion: monetary policy is largely nonsense.


P.S. (5th July 2013). For another argument against interest rate adjustments, see article entitled “Interest rate cuts versus stimulus…..” here.


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