Posted on 10/19/2010 6:51:36 AM PDT by WebFocus
In certain circles, it has become fashionable to argue that monetary policy is a superior instrument to fiscal policy – more predictable, faster, without the adverse long-term consequences brought on by greater indebtedness. Indeed, some advocates wax so enthusiastic that they support recent drives for austerity in many European countries, arguing that if there are untoward effects they can be undone by monetary policy. Whatever the merits of this position in general, it is nonsense in current economic circumstances.
A quarter-century ago proponents of monetary policy argued, with equal fervour, in favour of monetarism: the most reliable intervention in the economy was to maintain a steady rate of growth in the money supply. Few would hold that now, as the velocity of circulation turned out to be less constant than the monetarists anticipated. Countries seduced by apparent certainties of monetarism found themselves in a highly uncertain world.
Traditionally, monetary authorities focus policy around setting the short-term government interest rate. But, leaving aside the fact that with interest rates near zero there is little room for manoeuvre, the impact on the real economy of changes in the interest rate remains highly uncertain. The fundamental reason should be obvious: what matters for most companies (or consumers) is not the nominal interest rate but the availability of funds and the terms that borrowers have to pay. Those variables are not determined by the central bank. The US Federal Reserve may make funds available to banks at close to zero interest rates, but if the banks make those funds available to small and medium-sized enterprises at all, it is at a much higher rate.
Indeed, in the last US recession, the Fed’s lowering interest rates did stimulate the economy, but in a way that was disastrous in the long term. Companies did not respond to low rates by increasing investment. Monetary policy (accompanied by inadequate regulation) stimulated the economy largely by inflating a housing bubble, which fuelled a consumption boom.
It should be obvious that monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse. So monetary authorities have turned to quantitative easing. Even most advocates of monetary policy agree the impact of this is uncertain. What they seldom note, though, are the potential long-term costs. The Fed has bought more than a trillion dollars of mortgages and long-term bonds, the value of which will fall when the economy recovers – precisely the reason why no one in the private sector is interested. The government may pretend that it has not experienced a capital loss because, unlike banks, it does not have to use mark-to-market accounting. But no one should be fooled.
By contrast, if we extend unemployment benefits we know, not perfectly but with some degree of precision, how much of that money will be spent. Doubters of the effectiveness of fiscal policy worry that such spending will simply crowd out other spending, as government borrowing forces interest rates up. There may be times when such crowding out occurs – but this is not one. Interest rates remain at record low levels. Besides, anyone who believes in the power of monetary economics must believe that monetary authorities can undo these effects. (There are other, even less convincing arguments: that taxpayers offset future liabilities by reducing consumption. It would have been nice if this had happened when the Bush tax cuts of 2001 and 2003 were enacted; instead, the savings rate fell ever lower until it reached zero.)
A final argument invoked by critics of fiscal policy is that it is unfair to future generations. But monetary policy can have intergenerational effects every bit as bad. There are many countries where loose monetary policy has stimulated the economy through debt-financed consumption. This is, of course, how monetary policy “worked” in the past decade in the US. By contrast, fiscal policy can be targeted on investments in education, technology and infrastructure. Even if government debt is increased, the assets on the other side of the balance sheet are increased commensurately. Indeed, the historical record makes clear that returns on these investments far, far exceed the government’s cost of capital. When, as now, there is excess capacity in the private sector, such public investments increase output and tax revenues in both the short term and the long. If markets were rational, such investments would even lead a country’s cost of borrowing to fall.
Given the complexity of the economic system, the difficulties in predicting how expectations will be altered, and the pervasive irrationalities in the market, there is no way the impact of any economic policy could be ascertained with certainty. There may be some circumstances in which the effect of monetary policy can be accurately gauged. But recessions of this depth come only once every 75 years. What is true in normal times may be of little relevance now, especially as central banks engage in unusual measures such as QE.
To pursue austerity in the hope that monetary policy can reliably be used to undo any untoward effects, is, in short, sheer folly.
-- The writer is University Professor at Columbia University and the recipient of the 2001 Nobel Memorial Prize in Economics. The paperback edition of his book ‘Freefall’ with a new afterword is being published this month
The money power is clearly conferred on Congress (our representatives), and their abdication has led to the present crisis.
A Discussion On Economic Power With Joseph Stiglitz, Hernando De Soto and Naomi Klein...here...
Worth watching IMHO. Hernando De Soto is fantastic!
Thanks to FReeper dennisw for linking this conference on another thread some time ago.
[paraphrasing some of De Soto’s remarks]
He stated that we (America) defeated feudalism, patrimonialism, tribalism and set up a system...the property rights system and the contractual system that creates trust...because what is written on paper actually does reflect reality. Everything is recorded according to very precise laws that make things fungible, that makes things fixed in time in relation to other things...that make the paper trustable because we kept it at the level of real assets and we kept it at the level of mortgages.
Then all of a sudden we started creating the “banana republic” world...where now things don’t have to be recorded any more. We stopped using our property rights system and went into the Walt Disneyland of figment. Our “property paper” no longer reflects what is going on.
He also said...our legal system, that creates trust among each other, has ceased to inform about that “property paper” and therefore has collapsed.
“You stand in the midst of the greatest achievements of the greatest productive civilization and you wonder why it’s crumbling around you, while you’re damning its life-blood—money. You look upon money as the savages did before you, and you wonder why the jungle is creeping back to the edge of your cities. Throughout men’s history, money was always seized by looters of one brand or another, whose names changed, but whose method remained the same: to seize wealth by force and to keep the producers bound, demeaned, defamed, deprived of honor.”
“Watch money. Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion—when you see that in order to produce, you need to obtain permission from men who produce nothing—when you see that money is flowing to those who deal, not in goods, but in favors—when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you—when you see corruption being rewarded and honesty becoming a self-sacrifice—you may know that your society is doomed.”
~Ayn Rand
It is impossible to introduce into society a greater change and a greater evil than this: the conversion of the law into an instrument of plunder.
~Frederic Bastiat
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