Richard Gilbert's article "Why not print money?" in the Globe's Economy Lab toys with more radical monetary intervention as a response to the crisis. Desperate times, they say, call for desperate measures. The title (which was perhaps not Gilbert's at all) is more provocative than the article itself, which is mostly about tolerating higher inflation that could have beneficial impacts for easing our way through the current crisis.
Higher inflation would amount to a transfer of income from savers to borrowers, and from richer to poorer, so already I like it. What fascinates me is how this could be done. Turns out Gilbert is channelling arguments from Kenneth Rogoff back at the height of the financial crisis in December 2008:
Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20% or 30% instead of 5-6%. Indeed, fear of overshooting paralysed the Bank of Japan for a decade. But this problem is easily negotiated. With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.
It will take every tool in the box to fix today's once-in-a-century financial crisis. Fear of inflation, when viewed in the context of a possible global depression, is like worrying about getting the measles when one is in danger of getting the plague.
A couple years later, the U.S. quantitative easing program has essentially done the bit about creating new money by buying up government debt, mostly from the perspective of keeping down longer-term interest rates, rather than boosting inflation (on which the Fed maintains a hawkish tone). The idea behind QE2, the last round of Fed quantitative easing, was to force liquidity into the economy, which would induce more spending on actual goods and services that boost the economy. But it is not clear that the program has had much impact (though it is possible things would have been worse had they not engaged QE2). The people who need money in their pockets are not the ones holding government bond portfolios, so the program seemed mismatched from the outset.
Moreover, I'd dispute the underlying monetarist theory of inflation that more money leads to inflation per se. Greatly increased demand for goods and services relative to the productive capacity of the economy would lead to inflation. A supply shock (think oil prices) would lead to inflation. But encouraging a swap from holding government bonds to holding cash does not necessarily drive up demand (and thus inflation) for conventional goods and services (though it might drive up the prices of other assets, like gold or stocks, upon which people hold their wealth).
Now that QE3 is on the horizon, something more direct -- like actually increasing demand via fiscal stimulus -- would seem a better way to go. There are unemployed people and under-used resources in the economy. Governments can create jobs while investing in needed infrastructure (mass transit, efficient buildings, green manufacturing, renewable energy, early learning, etc). Also at the height of the crisis, I recall David Laidler calling for the Bank of Canada to finance federal deficit spending:
Well designed, [fiscal stimulus] can have immediate and beneficial effects on the sectors toward which it is directed; but more important for monetary policy, it must be financed by the sale of government bonds. If those bonds' initial purchasers are in the financial system, or among the public at large, the Bank of Canada can then actively buy them up, as part of its efforts to force liquidity into the economy; a few intermediate transactions could be eliminated, while achieving the same ultimate result, were the central bank itself to be the bonds' initial purchaser.
These recommendations will horrify anyone who believes that fiscal deficits financed by money creation are an inflationary route to ruin. So they are when the real economy is running near its capacity and financial markets are functioning normally. But when the real economy is depressed, and when deadlocked financial markets seem to be functioning normally, but in fact are providing insufficient stimulus to support a real recovery, those same policies will encourage the spending needed to restore normality.
There is nothing stopping the U.S. Fed from doing the same. The big barrier is psychological: once we start talking about "printing money" the danger is that millions of misunderstandings about what money is get amplified. In a fiat money system like ours it is the faith or belief that a colourful piece of paper has a certain value in purchasing goods and services that matters, and we need to be careful in shaking that confidence. That most people seek to get money (by selling their labour, or making investments, or buying low and selling high) to acquire things now or in the future is pretty obvious.
But how the money supply itself grows through the expansion of credit in the banking system is not broadly understood. The scale of private money creation is huge. Bank of Canada data for a number of monetary aggregates show that money expands rapidly during boom times, and slows down during downturns. Going back to 1996, M1+ has been at lows of about 4% annual growth, while peaking at more than 14% annual growth. M1++ peaked at around 20% annual growth through much of 2009. A broader monetary aggregate, M2++, did not grow as fast as that, but still was in the 8-9% annual growth range between late 2006 and late 2009. All of this money supply growth was compatible with low and stable inflation.
Then think about the size of these monetary aggregates. Measures in the BoC's Banking and Financial Statistics publication (Section E) show the size of the money supply based on a number of different measures: M1++ grew from $559.8 billion at the end of 2007 to $633.4 billion a year later, and $751 billion at the end of 2009. That is growth of almost $200 billion in two years, an amount that is close to the size of the federal budget. The bigger aggregate, M2++, grew from $1.62 trillion at the end of 2007 to $1.88 trillion at the end of 2009, that is, by about $260 billion.
So financing a $50 billion deficit through the Bank of Canada at a time when demand and private credit creation are slow is not a really big deal -- apart from fear that would be whooped up in the media by those who do not get this or whose economic interests were adversely affected. Even a modest uptick in inflation is likely to bring hysterical cries from those who own the debts that must be repaid. And higher but stable inflation can get locked in to price and wage expectations that impose some economic costs on society, although costs will be minor for inflation rates in single digits.
The biggest scare tactic is the image of wheelbarrows piled high with rapidly devaluing cash in inter-war Germany. The fear of change leading to hyperinflation could play a big role psychologically, even though modern circumstances are not analogous: it is not the 1930s and we are not a defeated nation forced to pay preposterous reparations payments to the victors. The subsequent German economic "miracle," it should be noted, stemmed from big deficits used for massive public works and military ramp-up that dropped unemployment very quickly. That's an aside from the broader horrors of Nazi Germany, but it is interesting that inflation was nowhere to be found.
Thanks to Richard Gilbert for getting me to dump all this out. He and Rogoff are right about tolerating modest inflation, wrong about the theory of inflation, but breaking out of the stagnation-come-double-digit-recession merits rethinking how we integrate monetary policy and fiscal policy in a way that creates jobs and supports the transition to a low-carbon economy by putting resources to work. And given that there are horribly polluting industries out there that need to be phased out, why not use public money to offset the economic hit of decommissioning? At a time of deleveraging and record high household debt, a new public sector stimulus program is just what is needed, rather than the conventional wisdom that nothing more can be done by governments.
This article was first posted on The Progressive Economics Forum.
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