Wednesday, 4 March 2015
Kenneth Rogoff discovers quantitative easing.
Kenneth Rogoff (along with his side-kick Carmen Reinhart) has given more academic credibility to austerity world-wide than just about anyone else over the last five years. First there were his dire warnings about the lack of growth in countries with a debt/GDP ratio of more than 90%. It then turned out that that claim was based on a spread-sheet error.
Apart from that, he has had numerous articles over the last five years in the Financial Times and other publications warning of the horrors of what he calls the “debt overhang”. The word “overhang” has a sort of menace, and for those into propaganda and psychology rather than logic, the psychological overtones of words are much more important than reason.
However, there was always a huge problem with the “debt overhang” theory: any old fool of a government can make its national debt disappear in a puff of smoke by simply printing money and buying the debt back, a process called “quantitative easing”. The result of QE is of course that base money replaces debt.
So Rogoff, as soon as he opens his mouth on the subject of QE which he does in this recent article, faces an obvious problem.
That is, he has two options. One is to claim that the impending disaster that stems from the “debt overhang” is equally applicable to base money. The second is to say that the impending disaster vanishes in a puff of smoke. But to admit to the latter is to say that an impending disaster can be removed by something as simple as printing more dollar bills, pound notes etc, which in turn implies the “disaster” claim is nonsense.
So his only LOGICAL course of action is to go for the first option, i.e. argue that replacing the “debt overhang” with the “base money overhang” solves nothing.
So is he sufficiently sure of his “dreaded overhang” claims to say out loud that QE simply replaces the debt overhang with an equally bad “QE induced overhang”? Well no. Rogoff in the above article basically just waffles and exudes hot air. He doesn’t say anything that the average Financial Times or Wall Street Journal doesn’t already know.
He does however go a small way towards the above mentioned only logical option, namely claiming that QE in no way reduces the “overhang” problem. He says “Why doesn’t the government just finance its entire debt at zero interest? Wouldn’t that free up public funds for other uses and save the taxpayers a lot of money? Yes, but here’s the rub: As the composition of government debt shifts to more short-term debt, the public finances become more exposed if some external factor drives up global interest rates. If all debt were very short-term and interest rates unexpectedly rise, taxpayers would suddenly face vastly larger interest costs as the debt gets rolled over at higher rates.”
OK, let’s examine the latter claim, and let’s assume just to keep things simple that government funds itself with ULTRA short term zero interest debt: i.e. plain simple old cash, or “base money” if you like.
Now suppose, horror of horrors, that “interest rates unexpectedly rise”. What of it? Rogoff claims “taxpayers would suddenly face vastly larger interest costs”. Whaaaaat?
How can government or “taxpayers” face higher interest costs when they aren’t borrowing anything? Rogoff’s claim is laughable.
In the case of closed economy (to keep things simple) those holding excess amounts of cash might easily try to dump or spend away some of their cash. That would result in excess demand. But that’s easily enough dealt with, at least in theory, by raising taxes and “unprinting” the money collected.
Depending on exactly which taxes are raised, there could be POLITICAL problems involved in doing that: certainly voters don’t like increased taxes. But to repeat, there’s no problem in THEORY. Moreover, the UK cut and then substantially increased its sales tax (VAT) in the recent recession, and scarcely anyone noticed. There wasn’t a single riot, demonstration or anything of the sort.
And a further point is that the economic illiterates in Congress and other elected bodies around the world are constantly pushing for a balanced budget or even a budget surplus. Thus they shouldn’t object to a request by the central bank and treasury to raise taxes, and/or cut government spending in some way or other.
Having assumed a closed economy above, there is of course the question as to what happens in an OPEN economy, particularly one where large volumes of its debt and currency are held overseas.
If interest rates world-wide rose substantially, obviously foreign holders of zero interest yielding dollars would dump them to some extent in search of yield elsewhere. That would cause the dollar to decline relative to other currencies. But the dollar has RISEN substantially over the last year or two, which has hit US based exporters. Obviously a panic and large scale dumping of dollars would be disruptive, but modest scale dumping wouldn’t do much harm.
The horrendous “debt overhang” problem about which Rogoff makes so much can be made to disappear in a puff of smoke by simply printing money and buying back the debt, i.e. QE. Thus the alleged problem is non-existent. Obviously that increase in the money supply could be inflationary (though in practice QE hasn’t proved all that inflationary). But to the extent that IT IS inflationary, that is easily dealt with simply by raising taxes and/or cutting public spending and unprinting the money collected.
And assuming the DEFLATIONARY effect of that unprinting is equal to the INFLATIONARY effect of the QE, then the net effect is zero. I.e. GDP would remain the same. Of course equalising those two effects would be difficult to do with TOTAL precision in the real world. But in principle there is no problem there: certainly no “debt overhang” problem.