Must
try to think before I speak.
I
argued in this letter in the Financial Times that an interest rate cut pulls
investment forward in time (a point also made by Mervyn King) and that that
effect works for perhaps two years. Thus Mark Carney’s announcement that
interest rates will stay low is of little relevance since the “pull forward”
effect is probably no longer operative in the UK right now.
Unfortunately
I forgot something else: the “hot potato” effect, which is a PERMANENT effect.
That is, to cut interest rates, a central bank prints money and buys up
government debt. That increases the amount of cash in private sector hands and
increases the value of government bonds. The owners of said cash and bonds then
have a surplus of cash and a surplus of net financial assets (or they are
NEARER having such a surplus than they previously were). Thus they will tend to
try to spend away that surplus, which causes a rise in demand.
But
that’s not to say that monetary stimulus is better than fiscal. One big
drawback of monetary stimulus is that the potato effect channels stimulus into
the economy via the rich. Apart from social considerations, there is no logic
in channelling stimulus into the economy exclusively via the rich any more than
there is via people with blue eyes or long legs.
I am
indebted to Scott Sumner who is keen on hot potatoes and who lets me think
aloud and put my foot in it on his site. That has sharpened up my ideas on
potatos, however I don’t think MMTers have ever been totally unaware of the
potato effect, because MMTers are always on about what they call “private
sector net financial assets”. And I don’t see any possible reason why
increasing PSNFA could be stimulatory other than via the potato effect.
__________
P.S. (28th Sept): Desperate attempt to save face.... I wish to point out that Mervyn King made the same mistake as I did, I think: i.e. he omitted the potato effect.
"Thus they will tend to try to spend away that surplus, which causes a rise in demand."
ReplyDeleteNot necessarily - since they are down on income. What you fear requires 'rational man' - and they don't exist. Rich people are only interested in the size of their portfolio.
There's not a great deal of evidence for the wealth effect on Bonds or Stocks - probably because ordinary people tend not to hold them.
Fair point. Monetary policy works via the rich. And as you say, they don’t change their weekly spending habits much in response to a change in net assets. In contrast, fiscal works via a cross section of the population, so that’s better (all else equal).
ReplyDeleteAnd MMTers tend to advocate creating new money and spending it into the economy (and/or cutting taxes) when stimulus is needed, which is a mix of monetary and fiscal, so ….. MMTers right yet again.
But there are others who advocate that “create and spend” policy, e.g. Positive Money.