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Monetary Policy For The Next Recession

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http://www.bloombergview.com/articles/2015-05-31/monetary-policy-for-the-next-recession

By pre-crash standards, the big central banks have made and continue to make amazing efforts to support demand and keep their economies running. Quantitative easing would once have been seen as reckless. The official term of art -- unconventional monetary policy -- tacitly acknowledged that.

But QE isn't unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It's quite possible that all three economies would fall back into recession. What then?

According to your economics textbook, the obvious answer is fiscal policy. But bringing fiscal expansion to bear in a sustained and effective way proved difficult after 2008. Next time round, the politics might be harder still, because public debt has grown and concerns about government solvency (warranted or otherwise) will be greater. Sooner rather than later, attention therefore needs to turn to a new kind of unconventional monetary policy: helicopter money.

One thing's for sure: The idea needs a blander name. Milton Friedman, who argued that central banks could always defeat deflation by printing dollars and dropping them from helicopters, did nothing to make the idea acceptable. Put it that way and most people think the notion is crazy.

How about "QE for the people" instead? It has a nice populist ring to it -- suggesting a convergence of financial excess and the Communist Manifesto. The problem is, it isn't bland. It sounds even bolder than helicopter money. "Overt monetary financing" is closer to what's required, but something even duller would be better.

Whatever you call it, the idea is far from crazy. Lately, more economists have been advocating it, and they're right.

The logic is simple. If central banks need to expand demand -- and interest rates can't be cut any further -- let them send a check to every citizen. Much of this money would be spent, boosting demand just as Friedman said. Nobody, so far as I'm aware, is arguing that it wouldn't be effective. What, then, is the objection?

Eric Lonergan, a fund manager and author of "Money," has a good, detailed explanation of the issues. He's right that the standard criticisms are based on misunderstandings.

One concern is that if a central bank starts giving out money, it will create liabilities with no corresponding assets -- thus depleting its equity. Compare with QE: This also creates liabilities in the form of money, but the central bank gets assets (the securities it buys) in return.

Does it matter that the central bank's equity is reduced? No. Standard accounting terms lose their usual meanings when applied to central banks. Money isn't a liability in the ordinary sense. Nobody is owed and nothing ever has to be paid back. In the same way, a central bank needn't worry about losses, even though accounting "losses" might sometimes arise -- as they also could under QE, by the way. An entity that can create money can't ever go bust.

The only non-trivial economic objection to overt monetary financing is that the central bank, having increased the supply of money, might find it difficult to control interest rates later. When inflation starts rising and the time comes for the central bank to tighten monetary policy, will it be able to?

The ultimate moral hazard issue free money!!!

https://mises.org/library/fiat-money-inflation-france

And this has been done in the past resulting in spectacular failure as the expectation was for the printing of more and more free money to stimulate the economy.

http://lynncoins.com/fiat-money-france5.htm

I have now presented this history in its chronological order—the order of events: let me, in conclusion, sum it up, briefly, in its logical order,--the order of cause and effect.

And, first, in the economic department. From the early reluctant and careful issues of paper we saw, as an immediate result, improvement and activity in business. Then arose the clamor for more paper money. At first, new issues were made with great difficulty; but, the dyke once broken, the current of irredeemable currency poured through; and, the breach thus enlarging, this currency was soon swollen beyond control. It was urged on by speculators for a rise in values; by demagogues who persuaded the mob that a nation, by its simple fiat, could stamp real value to any amount upon valueless objects. As a natural consequence a great debtor class grew rapidly, and this class gave its influence to depreciate more and more the currency in which its debts were to be paid.[85]

The government now began, and continued by spasms to grind out still more paper; commerce was at first stimulated by the difference in exchange; but this cause soon ceased to operate, and commerce, having been stimulated unhealthfully, wasted away.

Manufactures at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce. From time to time there was a revival of hope caused by an apparent revival of business; but this revival of business was at last seen to be caused more and more by the desire of far-seeing and cunning men of affairs to exchange paper money for objects of permanent value. As to the people at large, the classes living on fixed incomes and small salaries felt the pressure first, as soon as the purchasing power of their fixed incomes was reduced. Soon the great class living on wages felt it even more sadly.

Prices of the necessities of life increased: merchants were obliged to increase them, not only to cover depreciation of their merchandise, but also to cover their risk of loss from fluctuation; and, while the prices of products thus rose, wages, which had at first gone up, under the general stimulus, lagged behind. Under the universal doubt and discouragement, commerce and manufactures were checked or destroyed. As a consequence the demand for labor was diminished; laboring men were thrown out of employment, and, under the operation of the simplest law of supply and demand, the price of labor—the daily wages of the laboring class—went down until, at a time when prices of food, clothing and various articles of consumption were enormous, wages were nearly as low as at the time preceding the first issue of irredeemable currency.

The mercantile classes at first thought themselves exempt from the general misfortune. They were delighted at the apparent advance in the value of the goods upon their shelves. But they soon found that, as they increased prices to cover the inflation of currency and the risk from fluctuation and uncertainty, purchases became less in amount and payments less sure; a feeling of insecurity spread throughout the country; enterprise was deadened and stagnation followed.

New issues of paper were then clamored for as more drams are demanded by a drunkard. New issues only increased the evil; capitalists were all the more reluctant to embark their money on such a sea of doubt. Workmen of all sorts were more and more thrown out of employment. Issue after issue of currency came; but no relief resulted save a momentary stimulus, which aggravated the disease. The most ingenious evasions of natural laws in finance which the most subtle theorists could contrive were tried—all in vain; the most brilliant substitutes for those laws were tried; “self-regulating” schemes, “interconverting” schemes—all equally vain.[86] All thoughtful men had lost confidence. All men were waiting; stagnation became worse and worse. At last came the collapse and then a return, by a fearful shock, to a state of things which presented something like certainty of remuneration to capital and labor. Then, and not till then, came the beginning of a new era of prosperity.

Just as dependent on the law of cause and effect was the moral development. Out of the inflation of prices grew a speculating class; and, in the complete uncertainty as to the future, all business became a game of chance, and all business men, gamblers. In city centers came a quick growth of stock-jobbers and speculators; and these set a debasing fashion in business which spread to the remotest parts of the country. Instead of satisfaction with legitimate profits, came a passion for inordinate gains. Then, too, as values became more and more uncertain, there was no longer any motive for care or economy, but every motive for immediate expenditure and present enjoyment. So came upon the nation the obliteration of thrift. In this mania for yielding to present enjoyment rather than providing for future comfort were the seeds of new growths of wretchedness: luxury, senseless and extravagant, set in: this, too, spread as a fashion. To feed it, there came cheatery in the nation at large and corruption among officials and persons holding trusts. While men set such fashions in private and official business, women set fashions of extravagance in dress and living that added to the incentives to corruption. Faith in moral considerations, or even in good impulses, yielded to general distrust. National honor was thought a fiction cherished only by hypocrites. Patriotism was eaten out by cynicism.

Thus was the history of France logically developed in obedience to natural laws; such has, to a greater or less degree, always been the result of irredeemable paper, created according to the whim or interest of legislative assemblies rather than based upon standards of value permanent in their nature and agreed upon throughout the entire world. Such, we may fairly expect, will always be the result of them until the fiat of the Almighty shall evolve laws in the universe radically different from those which at present obtain.[87]

And, finally, as to the general development of the theory and practice which all this history records: my subject has been Fiat Money in France; How it came; What it brought; and How it ended.

It came by seeking a remedy for a comparatively small evil in an evil infinitely more dangerous. To cure a disease temporary in its character, a corrosive poison was administered, which ate out the vitals of French prosperity.

It progressed according to a law in social physics which we may call the “_law of accelerating issue and depreciation._” It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.

It brought, as we have seen, commerce and manufactures, the mercantile interest, the agricultural interest, to ruin. It brought on these the same destruction which would come to a Hollander opening the dykes of the sea to irrigate his garden in a dry summer.

It ended in the complete financial, moral and political prostration of France-a prostration from which only a Napoleon could raise it.

But this history would be incomplete without a brief sequel, showing how that great genius profited by all his experience. When Bonaparte took the consulship the condition of fiscal affairs was appalling. The government was bankrupt; an immense debt was unpaid. The further collection of taxes seemed impossible; the assessments were in hopeless confusion. War was going on in the East, on the Rhine, and in Italy, and civil war, in La Vendée. All the armies had long been unpaid, and the largest loan that could for the moment be effected was for a sum hardly meeting the expenses of the government for a single day. At the first cabinet council Bonaparte was asked what he intended to do. He replied, “I will pay cash or pay nothing.” From this time he conducted all his operations on this basis. He arranged the assessments, funded the debt, and made payments in cash; and from this time—during all the campaigns of Marengo, Austerlitz, Jena, Eylau, Friedland, down to the Peace of Tilsit in 1807--there was but one suspension of specie payment, and this only for a few days. When the first great European coalition was formed against the Empire, Napoleon was hard pressed financially, and it was proposed to resort to paper money; but he wrote to his minister, “While I live I will never resort to irredeemable paper.” He never did, and France, under this determination, commanded all the gold she needed. When Waterloo came, with the invasion of the Allies, with war on her own soil, with a change of dynasty, and with heavy expenses for war and indemnities, France, on a specie basis, experienced no severe financial distress.

If we glance at the financial history of France during the Franco-Prussian War and the Communist struggle, in which a far more serious pressure was brought upon French finances than our own recent Civil War put upon American finance, and yet with no national stagnation or distress, but with a steady progress in prosperity, we shall see still more clearly the advantage of meeting a financial crisis in an honest and straightforward way, and by methods sanctioned by the world’s most costly experience, rather than by yielding to dreamers, theorists, phrase-mongers, declaimers, schemers, speculators or to that sort of, “Reform” which is “the last refuge of a scoundrel.”[88]

There is a lesson in all this which it behooves every thinking man to ponder.

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I always thought that it would have made more sense for the BoE to have used the QE to buy Housing Association bonds to finance construction of new social housing. Relatively limited leakage of demand through export, highly labour intensive to support employment, and a lasting benefit to the country.

Of course, this wouldn't have allowed the government to monetise the deficit by the back door and hence was never going to happen.....

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How is giving money to people with limited wealth any more hazardous, morally, than giving money to rich bankers, crony capitalists and hedge fund owners?

I don't see a problem with air-dropping time limited vouchers to the public that can be used by companies to pay vat, corporation tax or vat bills. It wouldn't even be inflationary at our current levels of productivity and capacity. Comparisons with the French in eighteenth century are ridiculous.

Exiled Canadian - +1

Edited by Bill D'arblay

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The thing is you could drop money from helicopters and it would patch the structural problems for a while then you will be back at the same place within a few years.

The whole economic system needs reforming to resolve the issues. Land needs taxing, income needs less or no tax and inflation needs to be targeted at 0%.

If you printed shit loads of cash and paid off everyones debts, everyone would end up back in debt and the rich would end up with the all of the proceeds. Sio teh point of dropping money from helicopters would be what? A short term boost, just like dropping interest rates to 0%.

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John law, scotsman, financial genius, gambling addict and ruination of the french aristocracy.

Its an amazing story.

Nobody ever learns anything from history. unfortunatley we are all stuck with the consequence.

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But bringing fiscal expansion to bear in a sustained and effective way proved difficult after 2008. Next time round, the politics might be harder still, because public debt has grown and concerns about government solvency (warranted or otherwise) will be greater.

Errr....no.

As the IMF have (rather belatedly) now admitted, fiscal policy (inc. infrastructure investment) is precisely what is needed and is the optimal policy.

Austerians were & continue to be wrong but simply cannot bring themselves to stop their demented ranting about debt

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Errr....no.

As the IMF have (rather belatedly) now admitted, fiscal policy (inc. infrastructure investment) is precisely what is needed and is the optimal policy.

Austerians were & continue to be wrong but simply cannot bring themselves to stop their demented ranting about debt

Ten + years ago the Keynesian hoons were arguing for a housing bubble to repair the damage caused by the dotcom bubble... Now they're claiming that a sovereign debt bubble will remedy the damage caused by the housing bubble! Except for Japan, of course, where a sovereign debt bubble has helped bankrupt the country...

Edited by zugzwang

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Clearly the answer to any crash or bubble is just to add massive quantities of debt, blow more massive bubbles to replace the old ones and just carry on. No problems at all.

Makes you wonder why they bother with banks. Why not just give everyone their own money printer and tell them to get on with it?

Edited by Errol

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Ten + years ago the Keynesian hoons were arguing for a housing bubble to repair the damage caused by the dotcom bubble... Now they're claiming that a sovereign debt bubble will remedy the damage caused by the housing bubble! Except for Japan, of course, where a sovereign debt bubble has helped bankrupt the country...

As you say these hoons are still scrabbling about arguing about the effects of the top slice of their manipulative polciies.

They have no clue how real investment works, how real business decisions are made, how malinvestment kills good investment, how inflating cost bases undermines or destroys whole business sectors in a globally competitive market.

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The IMF is an organisation run by and for banks. Obviously.

In the next Recession there will be Bail Ins - deflationary.

They will take Base to 0.01% (Big Deal). Recession turns Depressionary.

QED HPC.

Jim Rickards' SDR seems to be coming as the next step.

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Ten + years ago the Keynesian hoons were arguing for a housing bubble to repair the damage caused by the dotcom bubble... Now they're claiming that a sovereign debt bubble will remedy the damage caused by the housing bubble! Except for Japan, of course, where a sovereign debt bubble has helped bankrupt the country...

Errr....no they're not.

The IMF are saying that on balance any *insurance* benefit arising from austerity is outweighed by the benefits of not cutting the deficit so rapidly. *Optimal* was the word Blanchard (or the paper he endorsed) used.

There is no "debt crisis". Never was. Twas a figment of the fevered imagination of a bunch of right wing nutjobs intent on cutting spending.

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[..]Whatever you call it, the idea is far from crazy. Lately, more economists have been advocating it, and they're right.

The logic is simple. If central banks need to expand demand -- and interest rates can't be cut any further -- let them send a check to every citizen. Much of this money would be spent, boosting demand just as Friedman said. Nobody, so far as I'm aware, is arguing that it wouldn't be effective. What, then, is the objection?

FOAD. Complacent greedy market-cheating... ah Crook by name...

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