Sunday, 20 November 2016

Does it matter if QE increases inequality?

This post is a re-write of a post with a very similar title published two or three weeks ago (on 3rd November 2016). Reason for this duplication is that the 3rd Nov. version contains several mistakes and I want to put them right. I’ll delete that 3rd Nov version (though it’s still available at Seeking Alpha site). Rectifying the mistakes actually involves altering very little of the text, but I like, as far as possible, getting everything right. So here goes.

Positive Money (PM) had a campaign recently to draw attention to the fact that QE increases inequality. As for the reason for the latter effect, that’s simple enough: QE involves giving cash to holders of government debt in exchange for that debt, i.e. Gilts in the UK and Treasuries in the US. That means saver / investors have cash to spare, some of which will flow to alternative investments like the stock exchange, housing, etc. That causes shares, houses etc to rise in value, which benefits owners of those assets, i.e. the better off. Plus there is no doubt a GDP increasing effect: some investors will make other investments which will boost demand and raise employment.

Malcolm Sawyer (economics prof at Leeds in the UK) thinks PM is wrong:

I asked Sawyer at the beginning of November on Twitter if he had set out any reasons for his latter claim, but haven’t had a reply so far. I also cannot find anything of relevance by Sawyer as a result of Googling. Anyway, my take on this question is thusly.

One response given by Mark Carney (governor of the Bank of England) to the above inequality charge was that “Every monetary policy action has distributional consequences. It is not for the central bank to address these.”

That’s not a bad point, but it’s a bit of a “passive and after the event” response. I.e. hopefully the BoE made it clear to government when QE was first mooted that it would increase inequality. Then the responsibility for letting inequality rise would lie exactly where it ought to lie: with politicians. I.e. if the BoE did not make that 100% clear, then the BoE could possibly be charged with being party to a wicked evil plot to increase inequality, and central banks are not supposed to be political.

Would QE money have been better spent on something else?

PM’s argument here is that QE money (which comes to just under £7,000 per head in the UK) could have been spent on something more beneficial than making the rich richer, plus more jobs would have been created, plus the effect on GDP would have been greater. (Incidentally, the above £7,000 figure is about right according to my back of the envelope calculations).

Indeed one way of spending that money would be to simply give it to UK citizens, as suggested in this PM tweet.

The empirical evidence is that households spend very roughly half of windfalls and save half. And spending about £3,500 per person would doubtless have been more stimulatory than QE, but it would also be too inflationary, I’d guess.

On the other hand, other material produced by Positive Money suggests spending much less, e.g. this video (at 4 minutes, 40 seconds). BTW thanks to Vincent Richardson (PM supporter) for the latter information.

Bang per buck.

As for the second alleged merit of the PM alternative to QE, namely that it results in a bigger increase in GDP per pound of stimulus, does that matter?

Well the answer is no, and for a reason pointed out by Milton Friedman, namely that stimulus dollars cost nothing in real terms, thus it doesn't matter how many jobs or increased GDP you get per £ or $ of stimulus. E.g. if stimulus comes in the form of literal helicopter money (printing £10 notes and dropping them from the sky) the cost of those notes is negligible relative to the face value.

The important objectives are to bring full employment and maximise GDP in the process. To illustrate, suppose there are two alternative ways of doing stimulus, both of which bring employment up to the full employment level. One involves printing and spending £200m and that increases GDP by £10m, and the second involves printing and spending £100m and that increases GDP by £9m, which should you go for?

Well it might seem that the second option is better value for money  because although GDP is increased by less, the costs of getting that extra GDP seem to be far less than with the latter first option.

Well the flaw there is, as Friedman pointed out, that the “costs” are entirely illusory. Thus the first option is best.

So, if the BoE thought the GDP maximising option was QE rather than spending the money in infrastructure or whatever, it then doesn't make any sense to say "but if we'd spent that money on infrastructure etc, we'd have got more jobs and GDP". Reason is that demand would have risen too far and we'd have got excess inflation that way. I.e. if the "more jobs per pound of stimulus" is the best way to go, then you need to employ fewer pounds, else excess inflation will ensue.

Why not QE the entire national debt?

Finally, QE is arguably not as bad might seem from the above points on inequality. That is, there are arguments for having no national debt at all (arguments set out for example by Milton Friedman and Warren Mosler). Thus continuing with QE and even accelerating it, while taking countermeasures to deal with inequality increasing effect WOULD arguably make sense.

But having said that abolishing national debt (i.e. replacing it with base money) arguably makes sense, QE in the form of having the central bank buy up corporate bonds is a different matter. Taking COMMERCIAL risks is not what central banks were set up for. PM has been actively opposing that, and I agree with them there


P.S. (4th Dec, 2016).    A friend of mine who has been in touch with Positive Money says they didn't intend to suggest that £6,000+ should be doled out to everyone in the UK. The idea was just to give an idea of the amount of money involved in QE. However, PM weren't very clear on that point in the above tweet. Room for improvement there I think.

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