This is not an argument for more government spending.
I advocated a big fiscal stimulus (spending, and some tax cuts), but as far as I can tell, the current political environment is not conducive to bigger short term deficits. Well and good. The intransigence of the Congressional GOP has been contemptible when they haven’t been arguing in good faith (which is most of the time), but there are nevertheless genuine differences in opinion about which reasonable people can differ, and in essence that’s what we have now with respect to the desirability of higher deficits in the next two years. Okay then.
So this thread is about printing money. Or a little more precisely, this is about getting dollars that have been printed moving through the economy. This is about moderate increases in the price level spurred by the monetary authority.
Of course, we actually use computers nowadays instead of “printing” the money, but the metaphor is still apt. Think of it as a giant press running hot, and you’ve still got pretty much the right idea. The problem is that that right idea is still incomplete. It’s not enough to print. We need to increase short term inflation (or nominal GDP) expectations a smidge. We need more monetary stimulus to accomplish this change in expectations, and we need it immediately (or really, two years ago, but the problem hasn’t changed). I’ll arrange this OP as a Q&A of sorts, anticipating the sorts of inquiries that are likely to crop up, so that I can provide reasonable responses to those questions.
OH-EM-GEE-HYPERINFLATION-ZORG-END-OF-THE-WORLD-GOLD-IS MAGICK-AAAAARGH!!!1!
You’re a fucking idiot. Find another thread.
But what a sec. I’ve read history. Governments that print a lot of money have hyperinflation. Don’t they? Am I something missing?
Printing a lot of money can cause hyperinflation. Absolutely. But there’s something more to it. Hyperinflation is spurred when governments print money specifically to pay their bills. The central banks of advanced countries do something else. They print money in order to achieve specific targets for broader policy goals, such as targeting a change in the price level. So the process is more complex than printing money => more money => inflation. That is to say that printing money doesn’t necessarily mean that there will be more money.
Pull the other one. It has got bells on.
I’m serious. I’m just trying to point out that there are different definitions of “money”. What the central bank directly controls is the monetary base, the M0. This is the printed bills I was talking about (plus certain digits on computers). And the US Federal Reserve has in fact printed a trillion new dollars into existence. This is to say that they more than doubled the M0. They printed a helluva lot of new money.
There are problems with determining the exact stock of money in its broader forms. Still, the M3, the broadest definition of money, is falling even as you read this. The M2 has effectively plateaued–it’s even dropped a touch in 2010. The Fed has printed a lot of new base, but that base isn’t getting lent out. Let’s not beat around the bush here. This is an enormous problem. You can find professional economists running the gamut, from liberals like Paul Krugman to libertarians like Milton Friedman, all agreeing that a drop in the money supply is a serious problem. In fact, it was Milton Friedman who (with Anna Schwartz) argued in the Monetary History of the United States that the Fed deserves blame for the Great Depression. Why? Because the Fed allowed the money supply (by which he meant the broader money supply, not the base) to fall.
It was only when FDR dropped the gold peg and let the currency depreciate that the country began to recover from the Depression.
But what if there’s inflationary pressure building? What if it’s a dam just waiting to break?
There’s no evidence to support this. None.
For one thing, you can’t argue crowding out of private investment when there’s a liquidity trap. Higher interest rates on government bonds are a sign of higher inflation expectations–which is a good thing, because higher inflation expectations are a sign of recovery. But right now, the government can borrow extensively without raising interest rates because there are so few private investment opportunities for the government to displace when the economy is doing so poorly. There are no inflation indications at all, despite the US debt. In fact, there is just the opposite. The dollar is strengthening fast. This happens in response to world financial concerns, because the dollar is still the world’s backup when everything else goes to hell.
And that is, in fact, one of the problems right now. A lack of confidence stemming from the European debt crisis is causing a flight to quality–with “quality” being defined as the United States dollar. That’s precisely why the dollar is stronger than we want it to be. We want it to be losing a bit of strength. And if the USD is what investors rely on in times of trouble, that’s an excellent demonstration in itself of the potential potency of more aggressive movement from the Fed.
Now, this can’t continue forever. The US will certainly have problems if we continue along the current debt path for another two or three decades. But that’s a long term problem with fiscal policy, not monetary policy. If that sort of crisis of confidence in the fiscal solvency of a country develops, there’s simply nothing that a central bank can do. Countries like Greece need to get their government spending back in order, and they’re going to have to suffer for it. But we in the US are not there now, and we won’t be for many years yet.
As Martin Wolf of the Financial Times notes in his own commentary about British money matters, you can’t apply a rational policy by giving the markets what you assume they will demand in the future. That’s just bloody stupid. You give markets what they desperately need in the present, and you set up a rule by which you change your policy to monetary contraction based on clear signals.
But the Fed can only print the dollars. They can’t force the banks to loan.
Force? No. Provide enough incentive so that the banks want to loan? Yes.
I’ve been talking here about “printing” money for convenience, but the Fed has more tools at its disposable than firing up the dollar presses. To echo Scott Sumner (who I highly recommend you read regularly, since does such an excellent job of explaining this issue), the Fed can charge banks a small fee on any funds they hold over their reserve requirement. This doesn’t force lending, but it does strongly encourage it.
But too much easy money was the original problem!
No, it wasn’t, though I can see how you can think that.
Were their mal-investments in the housing industry? Yes, of course. But you simply cannot look at the horrendous depth of the economic plunge we’ve experienced and blame it all on the pain of reallocating excess resources out of a single industry. This is a Great Recession here, and the problem is deeper than the collapse of an asset bubble, even one directly related to our construction industry. The problem this time was a general collapse in aggregate demand stemming from a crisis in confidence in our financial system (caused, yes, by the collapse of the bubble). Very similar to the Depression of old, when you get down to it.
It wasn’t easy money that was the problem. After the bubble collapsed, tight money was the problem–money tighter than it should have been–as you can see if you pay attention to the general price level, nominal GDP, and other measures broader than the mere monetary base. The explicit purpose of the TARP and other such financial packages were to encourage the banks to lend again. But they didn’t go to the source of the problem. The source is the Fed’s own policy that’s keeping money much tighter than it should be. And now that we’re undergoing another wave of fear, the dollar is strengthening yet again, and the Obama administration is talking about another fiscal stimulus, one which it likely won’t be able to pass through Congress. Meanwhile, the officials at the Fed sit with their thumbs up their asses. They expanded the base by a trillion bucks, sure, but now they think their job is over. They even appear to be eyeing rolling back what they’ve done so far. We are close to reliving the past, in all the worst ways.
We need more money. But we don’t necessary need to spend it when we can print it.
How does the Fed unwind its position if it puts too money dollars out there?
Easy. If collapsing the Fed balance sheet isn’t enough on its own, it can still pay interest on excess bank reserves. This is the opposite of paying a fee on those reserves. When the Fed was undergoing its unprecedented expansion of the monetary base, it raised its interest on excess bank reserves to a full percent. Even now, it’s paying a quarter of a percent. There’s no need for that. It should stop paying a red cent on reserves in order to stop encouraging the banks to do nothing with their money. If that doesn’t work, it should levy a small fee. If that doesn’t work, it can engage in quantitative easing by bringing down the interest rates of longer term bonds (by printing more money).
Well, I’m a conservative type. This makes me uncomfortable.
As a conservative type, you should agree with me on this. Historically speaking, monetary policy instead of fiscal policy is an economically conservative way to think of these issues–not the only conservative way to look at things, of course, but certainly the most informed of the conservative views. It was Keynes who argued that the government should spend money in a time of insufficient aggregate demand. It was the libertarian Friedman who argued that the government didn’t need to spend as long as the central bank did its job. It was Friedman who argued the primacy of money.
Unfortunately, Friedman made a mistake. He came up with a “rule” for the central bank to follow, and the rule was crap. That undermined his argument somewhat. This might be one of the most unfortunate oversights of his career, because if he’d come up with the right monetary policy rule the first time out, he could have potentially buried the idea of Keynesian government spending for good.
But aren’t you contradicting yourself? I thought you said you supported the Obama fiscal stimulus.
I did say that. But you know what? I could have been wrong.
Of course, I don’t think I’m wrong. For example, I was not wrong about the need for stimulus. Stimulus, in and of itself, is uncontroversial in contemporary macroeconomics. What the big debate is about in economic circles–and it’s a biggun, yes–is what kind of stimulus should be employed, and how big it should be. Someone like Paul Krugman (and not incidentally, someone like me) wants to throw absolutely everything at the problem, both monetary and fiscal.
Why is that? Because Krugman believes that the Fed can walk back any inflationary pressure from excess fiscal spending. But that begs the question: If the Fed is powerful enough to walk back any excess inflationary pressure from the government, can’t we just rely on monetary policy the entire time? Because if that’s so, we could start getting our debt situation under control right now instead of waiting for economic recovery. In simple terms: We don’t need to spend money when we can print it. I would prefer doing both, but I’m also a pragmatist. If money by itself works, then I’m fine with that.
That might sound like a perversion of conservative principles, but it shouldn’t be. The process is not conservative on its face, but the underlying reasoning still is.
It involves printing money now (or charging banks a fee on their excess reserves). But that policy can still be pursued according to an explicit Friedman-like rule that the Fed is forced to follow. Based on the sophisticated arguments from Scott Sumner, I think the ideal could well be nominal GDP (M*V) level targeting, where the Fed makes up for missing its target one year by raising its target for the next.
You can’t do without a central bank in a modern economy. But if you’re conservative, you want some clear controls on the central bank’s activity, right? And what could be clearer than an explicit rule that the central bank has to follow? It provides confidence to the markets, because they don’t need to predict any unusual movement from the central bank. They know what monetary policy is going to be, just by looking at the economy. And if the rule is designed just right, it could quite possibly end the need for counter-cyclical government spending for the express purpose of economic recovery. (It would not end counter-cyclical government spending from automatic programs like unemployment benefits, but the purpose of those are to mitigate the damage of the downturn to out-of-work families, not to lead to a recovery.)
What we don’t want to do in any circumstances is repeat the historical mistakes of the Depression, or of the Japanese, who themselves pursued a half-assed and inconsistent fiscal stimulus policy of government spending projects for years on end while their idiot central bank deliberately kept money tight and thus undermined the entire purpose of the spending. We don’t want to get ourselves further in debt, while our Fed counteracts the very reason why we’re spending that money.
The broad money supply is falling. We need to increase the money supply and the velocity of money, we need to moderately increase the price level, and ideally we need to start targeting stable long-term growth in our nominal GDP. We need more monetary stimulus, and we need it right bloody now.
(And yeah, the European Central Bank and the Bank of Japan should absolutely do the same, in part to mitigate the currency effects of our own policy, but also because they desperately need more money, too. Germany can eat some higher inflation if it means more stability for the periphery states of the Eurozone. Japan… Well, Japan’s a damn mess. I don’t know what they’re going to do. Something stupid, most likely. For example: doing nothing; continuing to neglect to increase price level expectations, as they’ve done for nearly two decades of needless economic stagnation.)
This is a technical topic but not, I hope, an incomprehensible one. I’m just pointing out one area, a big glaringly obvious area, where more absolutely could and should be done.