Sunday, July 21, 2013

QE money should be spent on general stimulatory measures, not on anything in particular.

Summary: If a central bank creates money out of thin air and buys securities (QE) the effect is distortionary. Therefor such money should be spent as far as possible on a broad range of stimulatory measures, e.g. cutting taxes and/or raising public spending.


Under conventional QE, central banks create money out of thin air and buy securities. One of the drawbacks of that is widely appreciated, namely that the effect is distortionary. For example asset prices are boosted (or fall less in value than they’d otherwise have fallen) which benefits the wealthy. Meanwhile the less well-off reap little or no benefit. (Indeed the other main element of monetary policy, interest rate adjustments, is also distortionary.)
Another distortionary effect is that, assuming QE works, additional money is spent, at least initially, in investment goods. That distorts the economy in the direction of investment good production, a distortion that has to be unwound come the recovery.
What is claimed to be a solution the latter problem was recently published by the New Economics Foundation: their publication “Strategic Quantitative Easing.” The latter publication advocates spending freshly created money on housing, infrastructure and one or two other items.

The flaw in that idea is exactly the same as the flaw in conventional QE, namely that a distortion is introduced which subsequently has to be unwound.
In fact, “Strategic Quantitative Easing” contradicts an earlier and brilliant work produced by the NEF and co-authors which advocated that new money should be spent on GENERAL reflationary measures. I quite agree. The NEF was right first time.
The above is not to suggest that spending freshly created money on general reflationary measures is without problems. E.g. if the new money subsequently proves to be too inflationary, there are political problems involved in reversing the process, i.e. raising taxes, withdrawing money from the private sector and “unprinting” such money.
However, every effort should be made to go for general reflation rather than bond purchases because there is no question but that bond purchasing is distortionary.

Another problem which will confuse less imaginative folk, is that spending freshly created money on what might be called fiscal measures (tax cuts / public spending increases) makes a mockery of the traditional split of responsibilities taken on by central banks and governments/treasuries. The quick answer to that is that that split is a nonsense. There is more on that nonsense in the NEF & Co work mentioned above.

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