Monday, Dec 08, 2008
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RGE: Printing money like mad to ward off deflation
Printing money is effective because it has the effect of putting more high-powered money into circulation. The aim is to increase bank reserves enough so as to increase lending that results from those reserves.
Posted by gardeniadotnet @ 10:47 AM (836 views) Add Comment
15 Comments
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1. stillthinking said...
Great post gardeniadotnet. The amount of quantitative easing by Japan seems to have been found out. Given the amount of savings that the Japanese have, you would have thought that some would be scared of the huge inflation they presumably have coming down the road.
Interesting really, because if Japan did "cure" their deflation, then BoJ rates would rise, and there would presumably be a run on dollar & pounds as people tried to get into high-yielding yen.
2. gardeniadotnet said...
The consensus of opinion of the commentators I have read so far seems to be not that Japan was wrong to use quantitative easing, but that it was used too late in the economic cycle to be effective.
3. Planning4acrash said...
Japanese were indeed scared about inflation. That's why they got involved in the carry trade, sending savings to places like New Zealand, where interest rates were languishing at over 8% for a time.
4. uncle tom said...
The Japanese had to go down the bizarre route of running up huge domestic debt while acquiring huge foreign reserves. Their core problem was having a persistant balance of payments surplus that they failed to address - until it came round and bit them.
We are in a very different mess, running up debt to service the economy while suffering a serious payments deficit.
The issuance of gilts is not far removed from printing banknotes - it will cause sterling to fall, leading to inflation
5. 51ck-6-51x said...
A very tight explanation. Nice one g.net
Japan was too slow, maybe the U.S. has been too trigger happy?
(As Uncle Tom points out) It is a little hard to compare JP & US, since JP had a budget surplus and went into debt to sort out their financial woes, however in my mind timing must be key to Q.E. if it's too late I think the monetary expansion is absorbed by the existing deflation, too early and those institutions that are able to will sit on any cash that comes their way (it's like a diffusion equation - too much drift in the first case, too many sinks in the second: like smoke you wish to stay in the air inside a room for some time - the former has too many open widows, the latter too many passive smokers and soft furnishings).
In both cases the new cash is not targeted anywhere, it is just hoped that financial institutions will efficiently allocate the new capital, this effectively supports the "bad tail" of financial institutions and encourages future, similar risk taking, however markets allocate capital more efficiently than politicians do or central banks might. Ideally capital would be targeted at future investment into society as a whole, but how can this be decided upon? Not by politicians, quite clearly, and probably not spent fast enough anyway!
So what changes should be made to the approach of Q.E. to allow the dampening of deflationary pressures via new lending, driven by the free-market to encourage efficient allocation, whilst discouraging the activity of hoarding and hence removing the support for the bad tail? (oh and here I note that the fact that those not in the bad tail know that the bad tail are supported so know they must hoard also to maintain competitive advantage.)
It appears that the current thinking would be to put the central bank in place as a direct lender. This can't be right - how could one institution perform efficient allocation (apart from by chance)? [rhet]
It seems to me that since hoarding makes commercial sense for the institutions that would be lending, there must be some mechanism to avoid hoarding the new capital created. I believe this could be implemented by involving the central bank as a feedback control system rather than as a bank, as per current thinking. This would involve the central bank purchasing government bonds directly from banks in an a small reverse auction and then monitoring the flow of the capital to allow assessment of further such purchases.
Anyone else have any ideas?
6. jamonit said...
There's something [else] I don't get with all this fear of hyperinflation in the long run...please excuse my ignorance...
- Banks lent against property [asset] values. Those values have plummetted.
- The Banks are now owed far more than the wealth against which they lent, so a big black financial hole has opened up.
- Gov't pumping cash into this hole, to 'fill it in', surely just takes us back to 2002 or whenever property prices were what they are now, and the banks were liquid.
- Those circumstances weren't hyperinflationary then, why will they be soon?
Surely all Govt spending is doing is replacing the wealth lost through asset devaluation, to take us back to where we were. The wealth that was taken to be in inflated property assets has simply evaporated, for ever. It was only conceptual anyway. Printing more paper is just replacing the evaporated wealth to replace lost liquidity, isn't it? How is that hyperinflationary? I can see that it would be so had the wealth not evaporated in the first place, because Govt would be adding to the pool of available money. But it isn't in current circumstances....it's simply replacing what's been lost. Isn't it?
The reason for this question is that I was told the other day by someone who should know that one of the uk banks, if the figures are really studied, could be said to short of as much as a trillion pounds...and it doesn't matter how much money govt throws around, the danger of hyper inflation is just negligible, if it exists at all.
Sorry, not an economist, fascinated by the subject but baffled when it seems to contradict intuition....
7. stillthinking said...
@jamonit
I think the reason why inflation is considered a danger later, is that should the government effectively replace the population as borrowers to maintain the status quo, then afterwards during a recovery, we will have the population borrowing -and- existing government borrowing, i.e. way too much, double basically. The only way to stop that would be to raise rates in which case the existing government borrowing would be a severe brake on any recovery.
What you say "it's simply replacing what's been lost." is my understanding as well, but it ignores the difficulties of how to actually replace what is lost. We still have food inflation for example. So the example I think of is ten buckets on the floor, all of them ideally would be say half full. But some aren't, some are nearly empty and some are more than half full. The only government response to replace the empty ones is equivalent to rain, in other words, they can't target the right assets. We see this already because the gov. is giving money to the banks to pump prime the consumers, but the cash -isn't- getting to the consumers. They can't accurately hit a single bucket because the water just goes all over the place.
Also, I don't think the trillion pounds you mention is really a trillion pounds. Just an effective trillion pounds. Really should be monetary base x no. of transactions=1 trillion. There aren't enough transactions so looks like deflation. Should the government actually pump up the monetary base to maintain stability then when the no. of transactions goes up, i.e. consumer recovery, back to the inflation problem again.
"Those circumstances weren't hyperinflationary then, why will they be soon" but I think they were, we just didn't see it because soaked up by central banks in asia. If they started spending now, dumping dollars and pounds, we would have -immediate- inflation. Which is why I think threatening central banks to release sterling reserves, use it or lose it, is the best way to proceed. Unfortunately they don't want to play ball.
phew....
8. 51ck-6-51x said...
jamonit:
"Printing more paper is just replacing the evaporated wealth to replace lost liquidity, isn't it?"
I think you may be confusing unrealised profits with capital. If I buy at 60 and hold until the price is 100 I have accumulated 'wealth' in that my asset is now worth more, however I have not realised this profit by selling. Printing money actually increases the amount of capital in the system. Capital gets passed around via financial transactions, whereupon real wealth becomes transferred (when I sell at 100 someone else is the buyer, although we both may increase our real wealth from the transaction, somewhere in the transactional chain this is netted out).
"Surely all Govt spending is doing is replacing the wealth lost through asset devaluation"
Printing money is not government spending. The money printed may be spent by government, but government also spends money that is already in circulation (taxes and spends, or borrows and spends).
I hope I have addressed your question satisfactorily.
9. stillthinking said...
Basically the whole problem is that savers aren't spending their savings, and they have to otherwise they bankrupt the debtors, who are the reality of their savings, because they need to work off their debts, and in so doing reduce savings.
These two are the same;
increasing debt=increasing savings
decreasing debt=decreasing savings
Economic activity is from the rate of change whether increasing or decreasing, doesn't matter. However, if you want to pay down debt but not decrease savings then essentially everything goes pear shaped, which is what we have now. Pear shaped.
10. matt_the_hat said...
To understand inflation substitute money with peoples time: the government can print more money but can't increase productivity therefore inflation.
This asset price inflation only becomes a problem when the asset price is not allowed to deflate: the government is effectively trying to monitorize peoples debt
11. uncle tom said...
Why inflation?
1 - most of the world's wealthy nations have a payments deficit with the world's poorer nations. That is unsustainable, and the value of the currencies of the developed nations must fall substantially to correct the imbalance.
2 - the current downturn has served to unlock some hoarding of commodities, resulting in a sharp decline in commodity prices. This however is essentially a temporary phenomenon, and the demand for commodities will soon be re-kindled by the developing world. With commodity prices rising on the global stage, and western currencies falling in relative terms, the cost of commodities in sterling will rise severely.
3 - excessive state borrowing, coupled to a falling currency, will propel gilt yields, and with it, interest rates. This will cause the currency to fall further, and propel inflation.
4 - even if, by some magic, we can be saved from external causes of inflation, the need to get millions of home owners out of negative equity will make inflation a political necessity. 5% would probably be ideal - IF the government can control it..
12. jamonit said...
Many thanks for your answers to my question @5. Much food for thought. [it's the lateral thinking aspect of economics, coupled with it's importance, that makes it so interesting I think.]
13. jamonit said...
Stillthinking @6. "We see this already because the gov. is giving money to the banks to pump prime the consumers, but the cash -isn't- getting to the consumers. They can't accurately hit a single bucket because the water just goes all over the place."
But if it's the banks that have the black hole, and the reason that govt money isn't being passed on to consumers is that the banks are busy pumping it all into that hole, then isn't that:
a - money aimed at the right 'bucket'
b - implying that all the govt has to do is make up the 'evaporated' wealth, rendering the banks liquid again. By converting the bank's black hole, or empty bucket, into interest payments on borrowed money. ...although then I suppose they'd be paying twice...hmmm...ok, still thinking..!
And I think I see the point of your first paragraph. Presumably though what's required is the needed govt borrowing to fill the bucket, coupled with subsequently constrained consumer borrowing....which would happen if interest rates went up..isn't that just the market working?
Perhaps I need to know too much more to be posting these questions here...I'll stop now.
14. stillthinking said...
All that is needed is to resolve the balance between savers and debtors. Debtors need to work, make something or provide some service, savers need to give the money for that service. Savings go down. Debts go down.
Savers need to spend. They aren't. Unemployment, deflation, collapse in sterling all come from that. The government is proposing to replace the spending of the savers. The government won't spend in a sustainable way and will distort the economy.
15. jamonit said...
OK, gottit. Thanks.