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TC: The Keynesians certainly thought like that, and that's why I find your emphasis on the fiscalist multiplier side of Keynes very disappointing. But can I just pick up a couple of issues? The first is to explain why, despite the Bank of England's enormous quantitative easing programme in 2009, we still have low growth of the quantity of money.

By the way, can I actually make clear that bank lending isn't by itself terribly important to all this? The important variable is the quantity of money, the quantity of money in bank accounts. And what's happened is that, since last autumn, the banks have been under huge pressure to raise their capital/asset ratios. This has meant that they've been reducing their risk assets, their loans and to some extent their holdings of risky securities. They've also been raising lots of capital rather than issuing deposits. So the result of those forces has been to deduct something like about £150-£200 billion from the quantity of money in the last year or so. Against that, quantitative easing had added about £150-£200 billion to the quantity of money. 

If we hadn't had quantitative easing the quantity of money in this country would have fallen in the last year by about five to ten per cent, which isn't that different from the rate of money contraction seen in the American Great Depression. So quantitative easing has prevented a calamity. Money growth hasn't risen very much, but it hasn't collapsed and that is a very good thing. I'm pretty sure, by the way, that Keynes would not have disapproved of that.

RS: No, I agree with you.

TC: And that's quite important — I think Keynes would have blessed quantitative easing. And further on that, my second point, which is crucial. The state can create money in at least two ways. One way is, if it's running a budget deficit, to finance that budget deficit from the banking system, either the commercial banks or in the extreme the central bank. OK, every economist knows that. But there's another way of doing it, which is to run a responsible fiscal policy and to monetise the existing public debt. And what I advocated in my pamphlet earlier this year on How to End the Recession was not to increase the budget deficit. I in fact put an increase in the budget deficit in the category of "bad and/or uninteresting ideas". Instead my proposal was that the government and the Bank of England, working together, should monetise the existing debt.

How? What about the mechanics? The government borrows from the commercial banks, the government then has a new deposit created for itself, and the government then uses that deposit to buy back its own long-dated debt. The result is to create new deposits, new money, in private sector hands. Do you know where I got this idea from, Robert? I got it from Keynes. 

RS: Yeah, yeah.

TC: And the polemical point is that quantitative easing isn't actually very original. The problem is that this part of Keynes's work has been neglected by the Keynesians, who are so obsessed by all the fiscal stuff that they have neglected his monetary work. And all through the 1930s, you're correct, there was this fiscalist agenda in Keynes's writings. In my view the agenda was mistaken and dangerous, but of course it was there. However, there was also, very strongly, advocacy of expansionary market operations, which Keynes called monetary policy à outrance. And all I've been doing in 2009 is advocating essentially the same policy.

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Ralph Mugrave
October 23rd, 2010
11:10 AM
In your flax economy you say that printing money destroys “the value of the participants' cash balances”. So how come the monetary base of the U.S. increased by an astronomic and unprecedented amount 18 months ago, yet inflation is currently at record lows? As distinct from the above evidence, and moving on to the INTENTION behind money printing, the intention or objective is to bring sufficient extra demand to bring full employment, but not so much as to cause excess inflation. Also in your flax economy you make the very unrealistic assumption that there is only one final product, namely clothing, and that the market for this is saturated. But let’s run with that assumption. An economy where there are no consumers who want any more goods or services is an economy where there is no unemployment. That is there is no one who wants to work extra hours so as to consume more. No Keynsian with any common sense would advocate money printing (or any other method of increasing demand) in these circumstances.

Richard Allan
March 29th, 2010
11:03 PM
I'm an economics graduate from the LSE, and I don't understand why this article concentrates on those parts of "macroeconomics" which we only teach to first-year students, and abandon in embarassment by the end of even a three-year Bachelor's degree. The ideas being discussed in this article have absolutely no currency with the economists that I've known. The idea that printing money, or increasing consumption, can somehow increase wealth is ludicrous. Anyone constructing a theoretical economy in his head should be able to see this for himself. Printing money will discourage people from holding cash balances; this will INCREASE instability in the economy by leaving people more vulnerable to liquidity demands. Increasing consumption can only destroy accumulated wealth all the faster. Let's say we have an economy where one worker grows food, another flax, and a third weaves flax into linen. They each "hoard" cash in expectation of future spending requirements. Now suddenly the demand for linen and therefore flax drops off; perhaps the market for clothing has become saturated. What's the commonsense response? Telling the two textile workers to find new jobs. But this would cause "excess capacity" in the economy (the land would have to be ploughed under before it could grow anything else, and the sewing machines are worthless) and "unemployment", which Keynesians can't allow. So what's their solution? Print money, destroying the value of the participants' cash balances, and use it to "stimulate the demand" for textiles, presumably by buying the stuff up and burning it (as we all know occurred during the New Deal). This allows the textile workers to keep their jobs! But what happens to savers? Well, either they have to shrug their shoulders and eliminate their "real savings", leaving them vulnerable to "liquidity shocks" (like a sudden bout of illness rendering them unable to work), or they switch their cash savings for, well, REAL savings; ie. stored food. But assuming the economy is producing the maximum amount of food possible (at least until the flax land is repurposed, which we've decided to prevent for the sake of the textile industry), increasing the amount of "hoarded" food is surely worse for food consumption than any amount of "hoarded" cash. At least someone was eating the damn stuff beforehand! So if the farmer decides to stop saving, and is then laid low by illness, there will be a very sudden "panic" in the economy as textile workers scramble for food production. But if workers replace their cash savings with food savings, inflation won't work any more! You can't print food with which to buy clothes; and since the farmer doesn't want to trade food for clothes (he has enough already), and doesn't want to hold cash (loses its value too quickly), we'll end up with the textile industry collapsing either way! The only difference is that in the meantime, we forced people to make an undesired switch from cash savings to either "no savings" (more volatility in the economy as a result of unpredictable expenditures) or "real savings" (reducing the supply of real goods for consumption). The "fiscal" alternative is a similar Devil's bargain. Either take the farmer's food in taxes now, or borrow food from him, promising to tax him later to pay back his own debt (Ricardian Equivalence shows that these two are exactly similar in terms of effects). If the taxes cause him to scale back his production of food, then you've reduced real wealth in the economy. But if they don't, then surely the taxable proceeds would be better invested somewhere else than in a failing line of business? The same can be said if inflation somehow doesn't cause anyone to alter his cash balances; the concept of opportunity cost means that wasting money (and goods!) by putting them to bad use is just as bad as destroying them. The only way that printing money can increase wealth is if there is genuinely idle capital in the economy which could be devoted to the production of real value (ie. happiness), but for whatever reason, is not. However, the only plausible mechanism by which this capital could be put to work by printing money is if wages are "sticky downwards", so the workers are effectively refusing to work for a utility-maximising wage. But firstly, printing money to force down their real wages was a stupid idea in Keynes's time (where index-linked wage contracts were already becoming commonplace) and is an even more stupid idea nowadays. It will just not have the desired effect. And secondly, if workers refuse to work for a utility-maximising wage, this must be regarded as a voluntary decision on their part; and as a believer in the Harm Principle, I don't believe it's the government's role to reverse voluntary decisions (or "indecisions"). And thirdly, I find it far more likely that diverting any funds to government will be used to reward unproductive special interests than to match genuine demand with genuine excess capacity. In conclusion, I find that this entire article is based on a vision of economics that is (i) out of favour with the economics establishment, (ii) easily disprovable by thought-experiment to anyone capable of consecutive thought, and (iii) a mere attempt to justify government intervention in the economy for its own sake, and for the sake of increasing the "mystique" surrounding economics in order to justify an increase in economists' salaries. The fact that it has attracted no comments thus far is evidence that it has been treated by the readers with the confusion and indifference that it deserves; I simply couldn't allow it to go unchallenged myself.

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