Saturday, 5 April 2014

ECB to do QE?

European Central Bank might do Quantitative Easing.
That raises a question as follows. Stimulus can be implemented by, 1, cutting interest rates (the favoured ECB tool to date), 2, by standard fiscal policy (borrow and spend) or 3, combining fiscal and monetary policy, i.e. simply having the government / central bank machine print money and spend it (and / or cut taxes) – advocated by Positive Money and others.
So there must be some optimum combination of the above three. So what is that optimum?
Well strikes me the optimum rate of interest is the free market rate, which casts doubt  on No.1. Moreover, interest rate adjustments if they work at all are DISTORTIONARY: that is the bring stimulus just via or primarily via investment spending. You might as well boost an economy just via extra car production and expenditure on restaurants. Moreover, the evidence is that interest rate adjustments don’t actually work. See here and here.
So interest rate adjustments are a farce.

Fiscal stimulus.
That consists of borrowing and spending. Now what’s the point of implementing a stimulatory measure (more spending) and then partially negating that with more borrowing? Isn't that the definition of lunacy?
Moreover, there is much disagreement as to how big the latter “self negating” effect traditional fiscal stimulus is (often referred to as “interest rate crowding out”). But (and here it all gets even more farcical), assuming stimulus is needed, the last thing a central bank will do is to let interest rates rise: indeed it will probably cut them. And that is effected by printing money and buying some or all the debt just created by the above fiscal stimulus…….which comes to the same thing, or much the same thing as No.3. Speaking of which…..
That leaves No.3: simply having the government and central bank print new money and spend it, and/or cut taxes. And that was suggested / advocated by Keynes.  Plus that policy comes to the same thing as fiscal policy followed by QE. Conclusion: the ECB is moving in the right direction.

Political and technical questions.
Of course the latter “print and spend” wheeze seems to raise a problem as follows. Those in charge of quantifying the amount of stimulus are often a bunch of professional economists (e.g. the Bank of England’s Monetary Policy Committee or the Office for Budgetary Responsibility). But deciding exactly what any stimulus money should be spent on is an obviously POLITICAL question.
Well the answer to that little problem isn't difficult: have the professionals do the technical stuff, like quantifying the amount of stimulus needed, while politicians do the strictly political stuff, like deciding exactly what stimulus money is spent on.
In fact that was all thought out by Positive Money, Prof. Richard Werner & Co. three or four years ago.

Reversing stimulus.
A possible defence of pure monetary policy is that it is easy to reverse. Well dollar for dollar it certainly IS EASIER to reverse than fiscal policy (that is, having the central bank buy or sell government bonds does not involve political problems, whereas reversing fiscal policy, e.g. by raising income tax or sales taxes or cutting public spending can involve political problems).
Well the answer to that is that “print and spend” is far more effective, dollar for dollar, than monetary policy. Thus while reversing monetary policy is relatively easy, each dollar of monetary policy is relative ineffective. So the “difficult to reverse” criticism of “print and spend” is not much of a criticism.
Moreover, the UK lowered and then raised it’s sales tax (VAT) during the crisis, and no one turned a hair.

Applying that to the Eurozone (EZ).
Applying the above “print and spend” policy to the EZ as a whole (i.e. a collection of national governments which are not averse to quarrelling with each other) would be more difficult that applying it to a monetarily sovereign country like the UK. But it wouldn’t be impossible.
It would be a case of saying to each individual EZ government, “you can’t borrow any longer, and you can only net spend what we, the Euro authorities (ECB in particular) say you can net spend”. That would cause some resentment in some countries, but then there’s no shortage of resentment at the moment in periphery countries at the austerity being imposed on those countries.


  1. Ralph-

    How can you contend that issuing Govt securities is "partially negating" Govt spending?

    Issuing securities results in MORE future spending in the form of interest spending not less.

    As we can see from QE, If simply issuing reserves (printing money) has turned out to be no more stimulative that combining the spending with a reserve drain mechanism (taxes or bond issuance) because the people who deposit their money at the central bank (buy securities) have almost no propensity to consume in the broader economy anyway.

    In other words, there is no clear evidence that shows that issuing securities is any less effective at stimulating the economy than just issuing reserves. If anything issuing securities is more stimulatory since it will result in future increased income for the securities holders.

    1. Auburn,

      The reasoning behind my “negating” point was that if government takes $X of cash off the private sector and issues $X of bonds to those it has borrowed from, that is deflationary, because the private sector’s stock of assets is then less liquid.

      However, as you rightly point out, that deflationary effect could be feeble because the cash rich are not going to reduce their weekly spending just because they’ve turned some of their surplus cash into bonds. But there is plenty of argument about that point: i.e. the question as to how much so called “crowding out” occurs when government borrows.

      So my attitude is, “if there is any likelihood of a deflationary effect from borrowing (given that the objective is stimulus) then what for heaven’s sake is the point of the borrowing?” I.e. government and central bank might as well just print money and spend it, and/or cut taxes.

      Claude Hillinger (a German economist) expressed similar sentiments when he said, “An aspect of the crisis discussions that has irritated me the most is the implicit, or explicit claim that there is no alternative to governmental borrowing to finance the deficits incurred for stabilization purposes. It baffles me how such nonsense can be so universally accepted. Of course, there is a much better alternative: to finance the deficits with fresh money.” See:

      Re “issuing securities” resulting in more “future spending in the form of interest spending”, that’s an entirely separate effect. That effect would work as you suggest if the extra “interest spending” was funded out of freshly printed money. But if it’s funded out of extra tax (which I suspect it is), then no additional net spending occurs. Warren Mosler has often made more or less your point, but like you, he seems to be vague on where that extra money comes from.

    2. Your response and position is more than fair.

      WRT where the additional interest spending comes from, there are two answers:

      1) From the place all Govt spending comes from, nowhere. So that entire concept is a logical fallacy

      2) with that said, if you're referring to simply a corresponding level offsets, then we could say that that money comes from an equal % deficit and taxation as all other Govt spending in a given year.

      Deficit spending doesn't pay for all of the dept of defense and then tax dollars pay for everything else. I would say that logically if you are spending $1T and taxing $500. Then all spending is offset by 50% taxation and 50% securities issuance. And this logic would apply to interest spending.

  2. I entirely agree with the policy views above.
    However some of the terminology used is a bit confusing to me.

    The terms "fiscal stimulus" and "fiscal policy" can be a bit confusing because they are used in various ways by different economists.
    You (and Positive Money?) seem to arbitrarily define fiscal policy as government policy regarding spending, taxation and borrowing, but EXCLUDING the issue of new money.
    This is inconsistent with the nore common definition which includes net spending deficits financed by printing money within fiscal policy.

    In other words net spending financed by by printing money is usually regarded as simply fiscal policy, rather than a combination of fiscal and monetary policy. On this definition is strange and incorrect to describe this Keynesian policy as "fiscal policy followed by QE".

    An example of the more conventional use of the term "fiscal policy" is given by Abba Lerner "Functional Finance and the Federal Debt" 1943 Social Research 10: page 39:
    "The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results ... "
    Again, this relatively minor issue does not diminish the views which you express.

    1. Fair point. I’ve just looked at 3 dictionaries of economics and one introductory text book, and they all agree that adjusting tax and government spending is included in “fiscal policy”. But they say nothing about whether any borrowing employed to fund extra govt spending is included in “fiscal policy”.

      I assumed that it was widely understood that such borrowing WAS INCLUDED in “fiscal policy”. But looks like I’m wrong, so I’ll have to be more explicit about definitions in future.

      I don’t agree with your claim that “net spending deficits financed by printing money within fiscal policy” is normally regarded as “fiscal”. Like I say, the 3 dictionaries and the text book I looked at said nothing one way or the other on that point. Personally, I’d classify money printing as monetary rather than fiscal. But it looks like the 3 dictionaries and the text book and I myself need to be explicit about definitions.


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