Friday, 2 October 2009

Let's ditch Keynes and monetarism.

Summary. It is evident from the long running “Keynes versus monetarist” argument that the effect of either policy alone is uncertain. Thus when attempting to stimulate economies we should employ a policy which is neither purely Keynes nor monetarist, namely unfunded deficits (exactly what has taken place in 2009). Conversely, when trying to dampen economic activity with a view to controlling inflation we should go for the opposite of unfunded deficits, that is a government surplus with no corresponding change to tax or borrowing.


The large amount of money printing that has taken place in 2009 has severely dented the idea that an increase in government spending necessarily has to be matched by increased borrowing or taxation. Hopefully this idea has not only been dented, but has been sunk once and for all.

The amount of money printed by the Bank of England is equal to the amount “Quantitatively eased”.

This money printing has been something of a last resort, or a desperate reaction to the severe recession of 2007-9. In fact, this policy makes good sense, even in more normal times. Plus, when governments want to dampen economic activity with a view to controlling inflation, the opposite of money printing, i.e. “money extinguishing” makes good sense.

Plain straightforward government spending with not tax or borrowing to fund the spending (i.e. money printing) is monetarist in that it increases the money supply. It is Keynsian, in that it constitutes an “injection”, or a net addition to aggregate demand (in exactly the same way as a sudden rise in exports raises aggregate demand).

The reason this policy makes sense is that it is both Keynsian and monetarist. Given the long running disagreement between Keynsians and monetarists, the effect of either policy alone is uncertain. Thus the effect of a policy that involves both philosophies should be more certain.

Of course there is ONE HUGE PROBLEM with this “neither Keynsian nor monetarist” policy: hundreds, if not thousands of economists have been kept employed over the decades at your expense and mine arguing about the finer points of the Keynes versus monetarist argument. These people are not going to relinquish this big source of employment lightly. If you earn a living arguing about how many angels can dance on a pinhead, then the last thing you will ever admit is that angels cannot dance on pinheads.

Another apparent problem is the inflationary consequence if government does not clamp down as soon as the additional money supply looks like causing excessive inflation. This is a bit like arguing that the power of car engines should be reduced to one percent of their present level, which would mean cars would be unable to move, which in turn would dramatically reduce car accidents. The big problem here is that this safety policy nullifies the whole point of car engines: making cars move.

Put another way, the effect of Keynsian borrow and spend (per pound of spending) is certainly less inflationary than that of an unfunded deficit. But this is hardly a merit. The whole point of stimulatory or reflationary policy is to stimulate or reflate. The benign inflationary effect of Keynsian borrow and spend (if the effect is benign) is simply a reflection of its ineffectiveness per pound of spending.

Put that another way, when aiming to stimulate an economy by a given amount, the total amount of additional spending under an unfunded deficit regime should certainly be less than under a Keynsian B&S regime, because the former is more potent. But it is false logic to call the former more inflationary. The inflationary effect of the two policies is probably much for a given amount of stimulation, or per additional thousand jobs created.

And finally, the potential inflationary effect of an unfunded deficit is pretty much the same as the potential inflationary effect of a sudden rise in export orders: both involve increased spending, and using money that has so to speak come from nowhere. There are few complains when export orders rise.

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