Sunday, 9 October 2011

Quantitative Obstinacy

About 20 years ago someone, (I forget whom, but the quote used to appear on NUJMB economics exam papers,) said that trying to steer the economy using monetary policy only was like trying to play golf using only one club.

Not only is it a "one club" policy, but it is an ineffective club. Expanding the money supply, which is what we used to call Quantitative Easing before this fancy new term was coined, is an ineffective method of stimulating the economy for two reasons and, in the current circumstances, is also highly dangerous.

It is ineffective because:

1. There is no guarantee that the money will be used for useful employment-creating purposes. When the Heath government tried it in the early 70' it mostly went into a commercial property boom. In 2008 the banks used the money to shore up their balance sheets rather than lend if for investment. What lending there was went largely into speculation in commodities rather than real investment.

2. Keynes likened monetary expansion as a means of economic stimulation to pushing on a piece of string. In the more prudent 1930s households would not borrow if they could see no means of paying back. That may be less true today, but, even without David Cameron's non-exhortation, households may be more concerned to pay off their credit cards rather than take out new debt.

More crucially, then and now firms would not borrow to invest if they see no demand. Large firms are apparently awash with cash at the moment but will not use it for productive investment when all the signs are for a world economic slump.

Quantitative Easing is highly dangerous because, if an when the economy does pick up, the excess money is likely to lead to high inflation. The 1950s explanation of "Too much money chasing too few goods" precisely describes the likely situation. Of course, if the Bank gets its timing right and does some nifty "quantitative tightening" that problem could be averted, but timing is not one of the Bank's strong points.

The obvious alternative solution is, of course, Keynesian government spending on public works: the infrastructure, green energy, clearing brownfield sites, social housing... and, if they can't think of anything better, burying the pylon lines. This policy would ensure that the money was spent on useful productive projects and also that most of it remained within the economy and, when workers obtained employment they would spend their wages and create additional demand via the Keynesian multiplier effect.

The government ignores history and has obstinately excluded this fiscal option. There are, perhaps, signs of a change of heart, and it may be that George Osborne's wheeze of "credit easing" is a method of squaring the circle and putting money where it will do most good without losing face. We shall see.

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