Thursday, 20 March 2014

Quantitative Easing – Get to the chopper!

What do you do when the economy needs a fiscal stimulus but there is no money for it?

Central banks have an ever expanding range in their toolkit to choose from to fix their individual economies but none of them seem to have worked so far.  This may be because they lack the right tool for the job.  In this case, the right tool is likely to be a large hammer in the form of a substantial fiscal stimulus but this is the preserve of governments who, at this point in time, are saddled with too much debt.  Yet, there is a way in which central banks could use monetary policy to act like a fiscal stimulus and generate the boost to demand that the global economy desperately needs.

Even new monetary policies are falling short

Economists thought we had it figured out.  Simply control the money supply by setting interest rates and it will be possible to ride out any booms and busts.  However, the weak recovery following the global financial crisis has shattered this belief.  Even manipulating the money supply using newly contrived measures such as quantitative easing has been less fruitful than hoped as well as creating unexpected problems

Quantitative easing has relied on a convoluted process where central banks create cash in order to buy bonds which frees up money for use elsewhere.  The problem has been that there is little demand for money in the actual economy as businesses are not keen to borrow as a result of the weak underlying economy.  Instead, what is needed is an instrument for inserting money straight into the economy.  This is because, rather than just cheap credit, companies need greater revenues from stronger sales in order to encourage investment and jump-start the economy again.

A fiscal stimulus fits the bill and has been tried already but only in small doses.  The key spanner in the works in this case has been high levels of government debt.  Before the crisis, politicians everywhere were almost as amped up as bankers and government finances were managed as if the boom time would continue forever.  The results have left us short of workable options to bolster the sluggish global economy.

Using Monetary Policy like a Fiscal Stimulus 

It may sound like a strange solution, but if monetary policy is not working and higher government spending is not possible, central banks could use their money-printing capacities to engineer a fiscal stimulus.  Rather than using freshly printed cash to buy bonds, central banks could just give it away.  Or, to use an analogy that economists like to use, drop money from a helicopter. 

Central banks operate the valves which control the supply of money, which is already being expanded on a temporary basis using quantitative easing.  The helicopter idea is a much more direct approach than shovelling money at the bond market.  Recipients of the cash would be free to spend it as they please, thus injecting money into the actual economy and creating a bonus for firms.  

The cash would not actually be in in the form of notes or coins but could be paid as a cheque or straight into the bank accounts of tax payers.  It strikes at the core of the main problem in the economy, a shortage of demand, allowing for more rapid results and less distortion compared to having surplus cash in the financial system.

The main drawback of this seemingly too-good-to-be-true policy is worries about inflation.  This is also the biggest obstacle as inflation is the primary concern of the central banks that would need to print the cash to be distributed.  It is the belief of many economists that it is the discipline of central banks which has kept inflation down over the past few decades.  Any sign that central banks might allow for more inflation is thought to push prices into a perilous upward spiral.  Yet, inflation is no longer the threat it once was and would not become an issue until the economic recovery was well under way.

Just like any handyman, economists have their favourite tools and are sometimes loath to admit that there might be a better option.  Unfortunately, it may just be a step too far for central banks to overcome their fear of inflation and leave the safety of familiar ground despite the extra firepower on offer.


  1. Fantasy land.

    How on earth are you going to determine who will be under the helicopter when the money is set free?

    As the GDP has not exactly plummeted, there does not seem to be a lack of demand as such. Just a lack of increasing demand to take on more debt to buy more stuff.

    The population is aging and the oldies simply do not want to buy more stuff, they already have houses and garages full. The young generation only wants a single device to make telephone calls, play games, watch YouTube and access the Unsocial Media world.

    Previously that would have required a computer, a TV, a telephone, travel, and a meeting place. Now they can sit anywhere and access all the stuff they want.

    The 20 to 30 crowd have problems finding employment, are returning to Mum and Dad because accommodation is too expensive, have given up thinking about buying a property and have the millstone of college debt to pay off.

    The army of cheap European and Asian workers, performing the jobs that the Brits do not want to do because they are turning into idle benefit dependants, save and send their income back to there own countries and try to avoid spending it in the UK.

    1. OH I forgot the other function,

      "take photographs, mostly selfies", which would also in the past have required a camera.

    2. Maybe you are right - maybe the UK has entered a period when growth in demand will be weak due to demographic changes. But a policy such as that referred to above would have been a faster way to revive the economy than working through the banking system.
      Rather than being worried about "who will be under the helicopter", I think that being able to target specific groups is one of the best parts of the policy. Giving money to rich people is not going to help the economy as they will just add it to their pile of cash. A policy of giving money to the less-well off such as the younger generation would boost the economy and help with issues of inequality which have become more pronounced over the past decade or so. Maybe then young people can do more than just take selfies.

  2. I wish there was some way of knowing that you had replied..... Maybe you could enable Disqus, then I would receive notification.

    If you give money to the young they will just go out and have a party, or travel to Spain and have a party, and those that don't will try to buy a house, further inflating the ridiculous prices now seen in the UK.

    When I was a student I lived in a house with two other guys.

    Now they live in expensive pods.

    How long will it be before "family pods" are brought onto the market?

    To help the economy of the UK the amount being spent on putting either a rental roof or a debt supported roof has to be reduced.

    But a one shot drop of cash onto the population would only provide a short term band aid. Money has to be invested into long term job creation. And the problem hindering that are all the rules and regulations enforced by government.

    I would never start a company in the UK. Before you even start trading there is so much BS to get through it is a major deterrent. And then afterwards you are restrained by employment regulations.

    1. Thanks again for your comment.

      The policy prescribed above is just like a one-time shot in the arm for the economy to get things moving. Businesses are not investing at the moment due to a lack of demand so this policy is one way of creating a temporary boost which may become self sustaining.

      Another option would be for the government to use the money to increase the supply of houses. This would raise demand but also deal with the problem of high house prices in the UK. However, I do not share your concern about high house prices. As long as the property market is not creating instability in the overall economy, house prices should not matter. People in the UK obsess too much about property and this is not healthy. The government could also do more to expand the land for property development but voters who own property may not like this.

      I do agree however with your worries about regulation. The government should make running a business as easy as possible but I do not think that it is as difficult as you make out. I have set up my own limited company and it seem to be relatively easy but I still use an accountant who look after a lot of the details for me.

      Hope this explains a few things. Sorry about the delays in getting my replies. If you have a blogger account or leave an email address. it may help but there does not seem to be anything that I can do.