Summary: If a central bank creates money out of thin air and buys
securities (QE) the effect is distortionary. Therefor such money should be
spent as far as possible on a broad range of stimulatory measures, e.g. cutting taxes and/or
raising public spending.
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Under conventional QE, central banks create money out of thin air and
buy securities. One of the drawbacks of that is widely appreciated, namely that
the effect is distortionary. For example asset prices are boosted (or fall less
in value than they’d otherwise have fallen) which benefits the wealthy.
Meanwhile the less well-off reap little or no benefit. (Indeed the other main
element of monetary policy, interest rate adjustments, is also distortionary.)
Another distortionary effect is that, assuming QE works, additional
money is spent, at least initially, in investment goods. That distorts the
economy in the direction of investment good production, a distortion that has
to be unwound come the recovery.
What is claimed to be a solution the latter problem was recently
published by the New Economics Foundation: their publication “Strategic
Quantitative Easing.” The latter publication advocates spending freshly created
money on housing, infrastructure and one or two other items.
The flaw in that idea is exactly the same as the flaw in conventional
QE, namely that a distortion is introduced which subsequently has to be
unwound.
In fact, “Strategic Quantitative Easing” contradicts an earlier and
brilliant work produced by the NEF and co-authors which advocated that new
money should be spent on GENERAL reflationary measures. I quite agree. The NEF
was right first time.
The above is not to suggest that spending freshly created money on
general reflationary measures is without problems. E.g. if the new money
subsequently proves to be too inflationary, there are political problems
involved in reversing the process, i.e. raising taxes, withdrawing money from
the private sector and “unprinting” such money.
However, every effort should be made to go for general reflation rather
than bond purchases because there is no question but that bond purchasing is
distortionary.Another problem which will confuse less imaginative folk, is that spending freshly created money on what might be called fiscal measures (tax cuts / public spending increases) makes a mockery of the traditional split of responsibilities taken on by central banks and governments/treasuries. The quick answer to that is that that split is a nonsense. There is more on that nonsense in the NEF & Co work mentioned above.
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