Thursday, 20 July 2017

Only an economist would claim that printing excessive amounts of money has no effect.

Izabella Kaminska in a recent Financial Times article claimed that stimulus cannot be implemented by having central banks print money with governments spending it (and/or cutting taxes) because central bank issued money must be backed by real assets. Title of the article is “Central bank digital currencies: the asset-side limitation.”

That argument is nonsense, and for the following reasons.

There are numerous examples, stretching back over two thousand years, of kings, rulers, governments etc declaring that the form of money they’ve decided to issue shall be the basic form of money in the relevant country. And that simple declaration works. In particular, it works if the state declares that its form of money is legal tender and that taxes must be paid in that form of money – or else. Or else you go to prison, have your property confiscated, or whatever.

The threat of prison or some other punishment is ample inducement for everyone to acquire a stock of government money so as to be able to pay taxes. That in turn gives that money value.

In contrast, assets owned by the ruler / government are irrelevant (though doubtless most rulers do own a substantial stock of assets). Having the military and legal power to collect taxes is what really matters.

Moreover, that reliance on tax collecting powers is very much in evidence at the time of writing in 2017. That is, the main asset of most central banks is government bonds. But why do the latter mere bits of paper have any value? It’s to a significant extent because everyone knows that the governments which issue those bonds can help themselves to near limitless amounts of money anytime by simply robbing taxpayers. Whether government actually owns substantial assets is near irrelevant.

With a view to bolstering her case, Kaminska cites a Vox article which makes similar claims about the futility of helicopter drops. Title of the article is “Helicopter money: The illusion of a free lunch.” And it’s written by two Bank of International Settlements individuals, plus one from the Bank of Thailand.

The first flaw in this article is the claim that helicopter money is never withdrawn from the private sector. The authors say, “The central bank credibly commits never to withdraw the increase in reserves.”

The authors do not actually quote any advocate of helicoptering to back that idea, and I’m not surprised, because the “never withdraw” element is not an essential ingredient in helicoptering.

It is true that the type of helicoptering advocated by Milton Friedman involved “no withdrawal”. That’s in his 1948 American Economic Review paper “A Monetary and Fiscal Framework…”. On the other hand it is more usual for advocates of helicoptering to argue that in most years a deficit is needed, while a surplus (i.e. “withdrawal”) will occasionally be needed given a serious outbreak of Greenspan’s irrational exuberance (i.e. excess demand).

Ricardian equivalence.

The Vox authors’ claim that there must be a promise not to withdraw is pretty obviously based on Ricardian equivalence, an idea which has long been popular with academic economists, despite it being obviously unrealistic.

Ricardian equivalence is the idea that consumers are forward looking and behave totally rationally. As far as helicopter drops are concerned, this means consumers will not increase their spending if they think government will in future withdraw that money, because consumers will allegedly need their increased stock of money to pay the taxes that make possible the withdrawal.

However, the idea that the average household thinks in that manner is just a joke.  As Joseph Stiglitz put it, "Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense."

In other words households behave much as you would expect: if they find they have more money in their bank accounts, they’ll spend a significant proportion of it. And indeed the empirical evidence supports that: for example the Bush tax cuts resulted in extra household spending by those whose taxes were cut.

The Vox authors then argue that helicoptering is likely to result in permanent zero interest rates. Specifically they say, “Either helicopter money results in interest rates permanently at zero – an unpalatable outcome to most, including those that advocate monetary financing – or else it is equivalent to either debt or to tax-financed government deficits, in which case it would not yield the desired additional expansionary effects.”

Well the first problem with that idea is that helicoptering will not result in permanent zero rates if the actual amount of helicoptering is relatively low. To take an extreme example, if the Fed did just one dollar’s worth of helicoptering, the effect would pretty obviously be negligible. Same goes for a million dollars worth.

However, if the amount of helicoptering was such that zero interest yielding base money replaced all government debt permanently, then that would of course constitute a permanent zero rate policy. But what’s so “unpalatable” about that?

A permanent zero rate was not regarded as “unpalatable” to Milton Friedman and Warren Mosler (founder of Modern Monetary Theory). Those two individuals specifically argued for permanent zero rates.

Admittedly there seems to be a problem with zero rates, which is that it makes interest rate cuts in the event of a recession difficult. There is of course the option of negative rates, but the latter are widely regarded as problematic.

However, dealing with recessions and excess inflation via interest rate adjustments is decidedly illogical and for the following reason. Given a recession (i.e. inadequate demand), whence the assumption that the recession must to down to inadequate borrowing, lending and investment and hence that interest rate cuts are called for? The recession may equally well be caused by a decline in one of the other constituents of aggregate demand, e.g. a fall in general consumer confidence or exports.

Moreover, the basic purpose of the economy is to produce what people want (both the items they normally purchase out of disposable income and the stuff they vote to have government supply to them in the form of public spending). Thus given inadequate production, the obvious or logical solution is to give household more of the stuff that enables them to buy goods and serves, and that stuff is called “money”. And the other obvious solution is to increase public spending. Both those two can be done via helicoptering.

To summarise, contrary to suggestions by Kaminska and the Vox authors, printing money and handing it out or spending it does actually have an effect (gasps of amazement). The initial effect is a rise in demand, and if too much printing is done (e.g. a la Robert Mugabe) the effect is excess inflation (more gasps of amazement). Moreover, if helicoptering goes far enough it can result in permanent zero interest rates but there is nothing obviously wrong with that.

1 comment:

  1. Must admit I was at a loss as to the whole argument she gave.Someone seems to have gotten at her for her to change her mind.Someone from the establishment who obviuosly disagrees with CB's just creating money without some balancing assets....aka double entry book keepoing
    Pity such small time, reactionary thinking is going on at the FT,just providing "more of the same" solutions.


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