Is Quantitative easing for People the worst idea ever? Hardly more than normal QE.
In a recent article, Ted Waller has suggested that ‘QE for People’ is the worst idea ever. In putting forward the opposing case, I present the misgivings in Waller’s analysis and show that QE for the People is an idea well worth pursuing. Instead, I suggest that there are worse ideas out there, like treating the cause of the last financial crisis (private debt) as the only possible solution.
Summarising QE for People
The recent launch of the QE for People means that the campaign is still in its infancy and it is important that it is not misunderstood, nor misrepresented. The basic tenets of the campaign resemble something along the lines of the following:
• The underlying cause of the global financial crisis was the rapid and excessive accumulation of private sector debt.
Plagued by a debt overhang, the Eurozone is currently suffering from a crisis of spending.
• The transmission mechanisms of conventional QE (and monetary policy in general) is severely impaired, as QE attempts to stimulate economic activity by encouraging the private sector to take on even more debt.
• QE entails creating new money and putting it into the financial economy rather than the real economy – exacerbating inequality, making economic recovery less stable, and promoting unsustainable asset bubbles in the process.
• To directly increase spending in the real economy, without increasing the net level of debt, the ECB can create money that can be distributed directly to citizens or to the government for public spending (or both).
Why is QE for People Attractive?
QE for People will achieve the goals of quantitative easing but will have a number of added benefits as well. It will allow for a reduction in the private sector’s debt to income ratio, it will give policy makers a much more direct tool to influence the real economy, it will allow the private sector to actively deleverage (pay down existing debts) without there being a reduction in spending/investment, the recovery will be more stable as well as sustainable, and it will be more evenly distributed throughout society.
Is it QE for People a form of Currency Debasement?
Waller suggests: “There is no way to get around the fact that it is currency debasement… Fundamentally it is no different than coin clipping by Roman emperors, Henry VIII's 90% debasement of the British pound, or Nixon closing the gold window in 1971.”
It appears that Waller is suggesting that the creation of new money inherently lowers the value of the existing money relative to current stock of goods and services being produced. Of course, if this were true, then it would have to be applied to the current process of money creation - where 95% of new money in the Eurozone is created by the private banking sector through the lending process.
The value of the currency is only diminished if fewer goods and services can be bought as a consequence of the newly created money. On the domestic front, for the currency to be debased, prices would have to increase as a consequence of the newly created money. If new money is created and spent on the production of new goods and services, then the supply of goods and services is increasing alongside the increase in spending. In this situation you have an increased amount of money ‘chasing’ an increased amount of goods and services being supplied. Money creation will not drive inflation if the rate of growth in supply is broadly consistent with rate of growth in spending.
On the international front, there is potential that the value of the currency (the exchange rate) may depreciate relative to other currencies. If this were the case, then an argument could be made that devaluation would allow for more goods and services to be exported. However, it is important to note that 80% of the Eurozone’s international trade is actually conducted within the Eurozone, so devaluation of the euro will have a limited effect on exports from the Eurozone as a whole.
Caution would be needed when deciding how to distribute the money, as distributing money through a citizen’s dividend risks increasing imports, eventually depreciating the currency. But a strong argument could be made that this is exactly what certain Northern European countries (Germany) need – as a citizen’s dividend would increase demand for imports from Southern European countries (Greece), helping stimulate Southern European economies. If used appropriately, QE for People could help the Eurozone address some of its problems in terms of macro-economic imbalances.
More significantly, exchange rates respond to inflation, interest rates, productivity, levels of employment, investment, savings, and the overall health of the economy. QE for People can be directed at investment to increase productivity, and to stimulate demand to encourage the mobilization of idle capacity to increase production. Stimulating and expanding the productive capacity of the economy, boosting levels of employment, and increasing incomes may equally lead to an appreciation of the currency (or at least prevent a significant devaluation of the currency).
Will Politicians be Able to Resist Temptation?
Next, Waller raises his next big issue with the QE for People campaign: “Once a government crosses into "making" money to pay its bills, more is almost impossible to resist.”
Advocates of the QE for People policy tend to stress a strict separation of powers as well as appropriate institutional checks and balances. In these proposals, elected politicians whether at EU or national level, would decide how to use the newly created money, while the independent administrative branches of the ECB and NCBs would decide how much money to create. This separation of powers would prevent politicians from being given direct control over money creation, avoiding the risk that political pressures could lead governments to abuse this power.
The decision to create money therefore would not be one of fiscal policy, but monetary policy. The central bank would only decide to create new money if it was failing to reach its mandated target (currently in the Eurozone price stability). This would mean that if inflation levels were below 2% the ECB would have to increase the amount of money being created and spent into the real economy. If indicators suggested that prices were going to increase beyond a desired level, the ECB would slow the rate of money creation.
Waller accurately points out that history has examples, where states have created money and their economies have consequently suffered. However there are also many examples of states proactively creating money to successfully grow the economy. Indeed, the proactive creation of money by governments has historically been the norm; only recently has it become the exception.
Is QE for People Just More of the Same?
Waller’s final criticism perhaps illustrates a general misunderstanding of the QE for People campaign: “The theory on which all of this is based is just that - a theory. The experimental test has been going on for seven years, and the realization is growing that it hasn't worked…”
Here we are in complete agreement with Waller. It is because QE and monetary policy in general has not worked for the last 7 years, that alternatives are needed. Relying on the status quo, QE and the reduction in interest rates, to stimulate the economy by getting the private sector to take on further debt is clearly not the way forwards. QE for People is a different proposal; one which would get new money into the real economy without increasing household debt. Rather than being the worst idea ever, it would actually work.
Credit Picture CC Day Donaldson