Thursday, 11 October 2012

Economists agree, but will the Greens listen?

It is often said that economists never agree. But when it comes to the Green's ideas on quantitative easing we seem to have a case where they do agree. Matt Noan doesn't like the idea here, Eric Crampton doesn't like it here and Bill Kaye-Blake doesn't like it here.

Now David Mayes, Professor of Finance at Auckland University, has been saying why he doesn't like the idea in the New Zealand Herald. Mayes writes,
Printing money is usually a last resort that seriously troubled countries use to stave off collapse, and not some mysterious trick that other nations have conjured up to achieve quick riches. More often than not it is disastrous, which is why it is not permitted under the EU Treaty.

New Zealand has definitely not run out of opportunities to use conventional monetary and fiscal policy if it feels the economy faces a lack of demand. So why move to the unconventional now?

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy. If the central bank then buys longer dated bonds or other financial securities (including commercial paper or mortgages from the private sector), it may continue stimulating the economy.

Evidence from a symposium being published by The Economic Journal suggests that this is achieving a little in the United Kingdom, the United States and the Euro area.

The problem is that it only works well if people fear major inflation and rush out to buy before prices rise. Once growth re-establishes again, the central bank sells all assets and mops up the extra money before inflation gets out of hand. That of course explains why it doesn't really work. If inflation is going to be headed off, then why buy now? Hence the weak effect.

Thus quantitative easing needs to be on a massive scale if it is to work. What central banks worry about now is how to extricate themselves elegantly from massive distortion, when the world economy turns round for the better. It has not been done before, so the chances of it going badly are high. After all, the easy monetary policy after the dotcom boom and the 9/11 disaster have turned out to be a significant cause of the present crisis.
In short, printing money is not a good idea. We don't need to do it and when it has been done it hasn't been very effective. Mayes continues,
Dr Norman's proposed scheme goes further. The Reserve Bank will buy Government earthquake recovery bonds to help pay for the Christchurch rebuild, and buy overseas assets to restore the Earthquake Commission's Natural Disaster Fund. Rather than borrowing government money to do this, it will simply create it. There lies the trick.

Maybe investors won't see through this, there will be little short-run impact and the inflationary pressure can be quietly reduced by restraint in the upturn. However, it could also weaken international confidence in the central bank's independence and New Zealand's commitment to fiscal prudence, hence increasing the price of new and renewing debt. Do we feel lucky?
Do we feel lucky? No would seem the obvious answer. The last thing we need is to have a Reserve Bank that is not independent of the government. Didn't the Muldoon years teach us at least this much?

So economists agree, but will politicians take notice?


Mark Hubbard said...

Sorry Paul, but I can't stand missing typos on my own blog ...

'We don't need to do it ...'

(Third para from bottom).

And no, the politicians won't listen. Following Cunliffe and Norman on Twitter, QE as a solution seems to comprise three tweets in four. Although exacerbating the problem is all the businessmen who agree and encourage them, without realising business cheering on those two, is like sheep voting for abattoirs.

Paul Walker said...

Corrected, thanks. And you are right, politicians won't listen as long as they see votes in not listening.