Tuesday, January 4, 2011
Modern Monetary Theory beats Tim Congdon.
Tim Congdon is one of the UK’s leading economists. For example he served on the Treasury's panel of independent economic forecasters in the l990s.
For some time he has argued that the money supply declines during recessions, thus artificially maintaining the money supply will help in a recession. E.g. see here and here. This is a crude argument. It overlooks various subtleties.
The first of the above links is concerned with QE, and Congdon argues that since QE maintains the money supply, this alleviates the recession. Well certainly QE boosts asset prices: nice for the asset rich. That in turn induces the wealthy to spend more (not MUCH more, though). But getting out of recessions by inducing the rich spend more is not a measure that has “social justice” written all over it. Moreover, why try to escape a recession by having ANY particular group spend more? Would it make sense to induce men to spend more but not women?
Private bank created money comes into existence as a RESULT of the private sector’s desire to do business and borrow for the latter purpose. Conversely, this stock of money declines in recessions, as a result of a REDUCED desire to do business. That is, deleveraging takes place. (Nothing new there: Walter Bagehot described this process a hundred and fifty years ago.)
Or as Robert Skidelsky put it in the second of the above links “….the basic cause of the collapse of the money supply was a collapse in the demand for loans…” Congdon, it seems, still does not understand this point.
The next “subtlety” is that boosting the money supply has no effect whatever till that money is SPENT – as David Hume pointed out in his essay “Of Money” 250 years ago.
To illustrate with a silly example, if government (as per Congdon’s advice) were to “borrow from the banking system” and withdraw all the new money in cash and store it in the vaults of the Treasury, there would be precisely no anti-recessionary effect – no effect on demand.
Or as David Hume put it in connection with money supply increases, “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated…”
In short, simply maintaining the money supply achieves nothing. The fundamental anti-recessionary factor is SPENDING.
The next question mark over Congdon’s idea is thus. What is the point of a government borrowing from the “banking system” when the government has its OWN bank: the central bank? That why let private banks take a cut out of what is really taxpayers’ or citizens’ money?
Presumably Congdon wants to expand private bank created money rather than central bank created money, as it is the former which collapses in a recession.
However, and first, he obviously does not regard this as too important because he is happy enough with QE which expands central bank created money, as pointed out above.
Second, a possible argument for expanding commercial bank created money is that expanding the monetary base expands banks’ reserves, which in turn enables them to lend more which could at some stage be inflationary. This idea is now generally regarded as obsolete. For example some countries (e.g. Canada) have NO reserve requirement. Second, the reality is that banking system lends when it sees viable lending opportunities. If adequate reserves are not there, the central bank just has to provide reserves, else the central bank loses control of interest rates.
Modern Monetary Theory is better.
One of the basic ideas in Modern Monetary Theory (MMT) is that in a recession, the government / central bank machine should simply create and spend more money (and/or lower taxes and leave more money in taxpayers’ pockets). And conversely, when inflation looms, the process should be put into reverse. The above anti-recessionary idea is pretty much what Keynes advocated, though a contemporary of Keynes’s, namely Abba Lerner, made the above point in a more open and blunt fashion than Keynes. Plus I think Lerner added the bit about “putting the process into reverse” (though I might be wrong there). Thus Lerner is often regarded as the founding father of MMT.
Now creating AND SPENDING extra money in a recession makes more sense than just creating money, for reasons given above. So MMT beats Congdon there.
Second, MMT advocates having the government / central bank machine do the money creation, not commercial banks. As pointed out above, there is not much sense in letting commercial banks charge millions to do something that the central bank can do with a click on a PC mouse. So MMT beats Congdon there as well.
Game, set and match to MMT.