I’ve read quite a bit in recent years that Japan is or was having a real problem with deflation. I can see why deflation is a bad thing for the economy — if prices are constantly going down, people and companies are tempted to save now and spend later.
However, I also know that if the government pays its expenses by printing more money, the expansion in the money supply causes inflation. Why can’t countries that are suffering from deflation just print more money to cause enough inflation to cancel it out? This would have the added benefit that they could afford to cut taxes. I don’t know all that much about macroeconomics, so I must be missing something simple, but what is it?
Monetary policy (adjusting the money supply to affect the interest rate) is a useful tool for macroeconomic intervention but it can also be overused. Governments that in the past, “paid their expenses by printing more money” haven’t always had the best results with that sort of approach; hyperinflation is no joke. However, assuming that the government is using monetary policy responsibly, it is a viable tool for combating a declining price level.
The situation with the Japanese is a little more complicated. Some would argue that near zero Japanese interest rates work to constitute something of a “liquidity trap,” where temporarily increasing the money supply no longer causes the currency to depreciate. They are basically screwed because interest rates can’t go any lower than zero. This is important because…
Increasing the money supply lowers interest rates which, all things being equal, depreciates the currency. This is based on the assumption that people will add money to their portfolios only if bonds become less attractive to hold. But with an interest rate of zero people are indifferent because the nominal rate of return for either money or bonds is zero. So if the government tries to raise the money supply by buying bonds on the open market people will be all to happy to exchange their bonds for money but there will be no change in the interest rate. Clear as mud? Thought so.
Yet all this talk about temporary increases in the money supply is not the same as a permanent increase in the money supply. A permanent increase would raise expectations of a depreciation in the currency that would lead to an expansion of output and an actual depreciation of the currency. That is, of course, if Japanese officials had any sort of credibility at all in making promises that a monetary expansion would be permanent (which they don’t). Fears of depreciation and inflation within the government have made the markets suspicious of any such promises and any monetary expansion is likely to be regarded as temporary.
I’m not a full blown economist yet so I might be missing something, but from what I understand so far this seems to be the main problem with the strategy you suggest.
The Fed has been expanding the money supply of the US by so much it would make your head spin. But there ain’t no inflation. So there is more to it than printing money.
People have to make all that money circulate. It’s called velocity. And there just isn’t very much velocity in today’s US economy(except the housing market, which is just about to crash, IMHO).
Money is cheap right now, but business doesn’t need it, because they are worried about the demand. Manufacturing is dying in the US. Product lines are idle. 100 person crews are down to 20. And until the consumer spends, business won’t spend the money to make products.
And the consumer can’t spend much more, because they are at their limit. The credit card debt is at a record high. People are tapped out. So the consumer can’t spend much more. They just don’t have money.
Um, the money supply has been expanded, but the consumer doesn’t have it (I guess what they have is maxed debt–they haven’t been spending money, they’ve been spending their credit). So who does have the money?
Literally, whoever the central bank buys the bonds from. The central bank changes the money supply by buying or selling domestic or foreign assets. When they buy something they create money and give it to the seller, when they sell assets they take the money they get and take it out of the money supply. In order to have any influence on the interest rate they work in large sums of money, so generally the trade is going to be with financial and banking institutions. Of course once the extra money is in the economy and circulating around, pretty much everyone has it.
Heh, I wish I understood it better myself - I’d probably be able to make it more intuitive. The simple answer is that Japan’s banking system is falling apart and nobody wants to take the medicine that will pull Japan out of it. If the G7 got together and coordinated their monetary policy to affect a change in Japan’s money supply that would help immensely.
Still, whats to stop a government from printing a couple hundred dollar bills(or in the case of Japan, 10,000 Yen notes) for every person and mailing them out? Seems to be the easiest way to increase the money supply to me, rather than go throught the complications of bond buying, and bank interest rates to me.
This is what I don’t understand. If the government of Japan gave, say 1 yen to every person in the country, I don’t think there would be any significant effect. If they gave every person 10,000 yen, hyperinflation would result. Isn’t there some happy medium that would get rid of their deflation problem without causing too much inflation in return?
The money supply is directly linked to the price level. If everybody suddenly got a couple 100 dollar bills out of thin air then prices would also rise to reflect the increase. Sellers aren’t stupid, they would realize that the real value of a dollar bill has gone down (there are more of them floating around) and they would not want to trade their goods for depreciated dollars. What’s more, if the government were to keep printing money then it would be reasonable to expect that any dollar you have today is going to be worth less tommorow. No one would want to have any money, and everyone would be likely to try and spend their money on goods as fast as possible.
This has happened before and one of the most striking examples has been post-WWI Germany. In order to pay the reparations imposed by the Treaty of Versailles the German government tried to print enough money to fit the bill all at once. This made the currency worthless. Workers had to be paid in wheelbarrows full of paper money and they would have to run out and buy food and other necessities as quickly as possible before prices went up even higher. Because of the way expectations work hyperinflation feeds into itself and tends to spiral out of control. Banks collapsed, investment died away and consumption was a constant race against the inflationary clock, a race for crappier and crappier prizes. Eventually the currency had to be done away with entirely and replaced, but even then the new currency would only have value based on the government’s promise that it would not “just print money.”
Because paper currency is only meaningful as a store of value, the system built on it will only work as long as people can reasonably expect the paper to store that value. Because we can trust the central bank not to go crazy and print so much money that the money we have on hand is worthless by comparison we are content to keep our wealth in terms of a commodity that would otherwise only be useful as kindling. When samclem brings up the velocity of money as one reason why we aren’t seeing massive inflation that is true, but another reason is that the amount of inflation predicted is relatively low. We trust the Fed to keep a tight rein on the amount of inflation, we also trust the Fed to adjust the supply of money to counter-balance shocks to our economy that might lead to inflation. This is done by keeping interest rates stable which by extension helps keep expectations stable… all to keep the economy stable.
Isn’t that like telling someone who’s starving to death they can’t eat because they will get fat?
The problem we are trying to solve is prices are not rising/ or falling. Assuming it was known that the printing of money would stop as soon as there was any hint of inflation (or more than the target rate, 3% I think) what would be the problem?
And instead of mailing out cash how about - “We are not running a deficit this year, we’ll just print the extra money we need.” or “No taxes this year (or a major tax cut), we’ll just print enough to make up the difference.”
The problem is that consumers don’t spend, waiting for prices to go lower.
Paul Krugman wrote an article about this, mentioning (though not specifically endorsing) one simple apprach: Using a lottery to invalidate banknotes! Say, all serial numbers ending in ‘87’ become worthless at the end of the month, though you don’t know in advance which numbers. That should get people to spend their cash!
A simple approach I thought of would be to refund part of the VAT, but make it temporary. That is, 10% VAT is cut to zero this month, to 1% after 2 months, to 2% after 4 months …
Perhaps neither of these schemes is fully workable, but I agree with OP that there should be some simple way to combat deflation.
Hilarious, but would fail massively. People would rush to deposit them, but banks wouldn’t want to take them, and some business would demand to be paid in something other than cash. Basically, this would be a nightmare. I sincerely hope Paul was being funny, although he frequently proposes nonsense in other areas.
Whoa… I didn’t look at the date when I posted :o I searched for deflation because it has been in the news lately and it seems like a super easy problem to solve (By printing money)
I am far from an economic expert but what I have heard from people who are experts that an inflation rate of 2-3% is the best case and is the feds unofficial target. From everything I have heard deflation is a huge problem.
As far as I know that money was just a tax break - if the government borrowed to get it there would be no net change in the money supply.
It really must have pissed off the Beck-Limbaughist crowd when Krugman won his Nobel Prize. Google “Krugman deflation” if you actually want to learn something about the topic. But I’m afraid you’ll have to skim through a lot of real economic thought if all you want is to get to the “joke” and misconstrue it.
Sure, if you kept printing up money and dropping it into people’s mailboxes (or equivalent), eventually people would start spending. But how many billions of dollars would you need to print up and hand out before folks started to feel comfortable enough to start spending? Further, once people start spending and the velocity of money begins to increase, you can stop printing. However, how would you then effectively destroy those extra printed dollars and prevent runaway inflation? The Fed controls the money supply through open market operations, but how do you collect dollars that you had previously given out freely?
