Thursday, 22 October 2015

Krugman criticises peoples’ QE.

I have a huge respect for Paul Krugman. His articles are always brief, to the point, and logical.

He normally sets out the core issues in any argument in a hundred words or less, as compared to numerous other economists who employ thousands of words, often failing to even get to the root of any argument.

This article of his deals with what is sometimes called “peoples’ QE”, i.e. having the state simply print money and spend it in a recession, rather than having the state borrow money first, and then print money and buy back the bonds issued (i.e. QE).

He starts by assuming the central bank is part of government. That’s a not unreasonable assumption: one that MMTers often make. As Krugman puts it, “It doesn’t take fancy analysis to make this point — just an acknowledgement that in financial terms, at least, the central bank is part of the government.” (That’s why I used the term “state” above – a word intended to refer to government and CB combined.)

Krugman continues (I’ve put his words in italics):

"So, compare two cases. In case 1, the government runs a budget deficit, which it finances by selling bonds to banks (it could be anyone, but let’s assume that banks are the buyers.) At the same time, the central bank — an arm of the government — is engaged in quantitative easing, buying bonds from banks with newly created monetary base.

I think we’re all agreed that the second part of this story isn’t very effective in a liquidity trap; the limitations of QE are why we’re even talking about helicopter money.

But now consider case 2, in which the government pays for deficits simply by “printing money”, that is, adding to the monetary base.

How do these cases differ?

At the end of the day, the government’s financial position is exactly the same: debt held by the private sector is the same, and so is the monetary base. The private sector’s balance sheet is the same too. The only difference is that in case 1 banks briefly hold some government bonds, before selling them back to the government via the central bank. Why should this matter for, well, anything?"

Well there’s nothing much I disagree with above. In particular I agree that “balance sheets are the same”.  However, I suggest there are two significant differences between the two scenarios.

First, assuming the point of “print and spend” or “borrow and spend” is to impart stimulus, what on Earth is the point of borrowing? It’s pointless because the effect of borrowing is anti-stimulatory. I.e., as I’ve pointed out numerous times, to make borrowing a part of any sort of stimulus exercise is like throwing dirt over your car before washing it.

Also, the mere fact of borrowing creates jobs for a swarm of Wall Street and City of London paper pushers who receive huge salaries for doing nothing of any significance. (That’s just one example of a point made by Adair Turner, namely that much of what banks do is “socially useless”).

Politicians don’t understand government debt.

Second,  a large majority of politicians (and a significant proportion of so called “professional” economists) equate government debt with household debts. That is, they think that government debt must be kept within limits for the same reason as a household or firm has to be careful of how much debt it incurs.

And that leads to the absurdity of Congress placing artificial limits on the amount of debt government can incur, which in turn means the US government machine periodically closes down, and/or unemployment stays at an artificially high level.


So all in all, while Krugman’s points about balance sheets are correct, I suggest there are significant benefits to be had from PQE, as opposed to having government fund its spending via borrowing, with relevant bonds then being bought back by the central bank.

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