Posted by: Dirk | June 18, 2013

Overt Monetary Financing

Adair Turner in his keynote at INET Hong Kong has talked about a thing that has been and still is taboo in economics: overt monetary financing. The treasury under this scheme creates money that is not offset with a liability of the government at the central bank. The main part of the talk starts at o:47:57:

Now, William White – formerly at the Bank for International Settlements – has published an article at Project Syndicate. He is sympathetic to breaking the taboo:

[…] a lively debate on this issue has begun, which is useful for two reasons. First, it widens the scope of possible tools to manage the ongoing crisis. Second, it reminds us that there is a current crisis that needs managing.

The article is well written and do recommend it. Let me just point one thing out. German Bundesbankers are mostly a monetarist crowd. A rise in the monetary aggregate, they fear, creates inflation. This has been wrong before the crisis, and it is wrong during the crisis. White states:

As for the Simons/Friedman proposals, they come down to a rule for the rate of growth of the money stock with the objective of “ensuring” price stability. The problem with this assertion is that it depends on the assumption of a stable demand function for money (the “V” in MV=PT), which experience shows is far from being the case. As Gerry Bouey, my old boss at the Bank of Canada put it, after we gave up our monetarist experiment of the late 1970’s, “We didn’t abandon the monetary aggregates, they abandoned us”. Moreover with the spectacular increase in the size of the shadow banking system, I suspect the problem of monetary instability has become even worse in recent decades.

The problem in Germany is that policy makers are ignorant. They have failed to understand that reality is not a fit to their model and instead of changing their model just continued to cling to it. Now the economy is a resilient thing. Just like steering an oil tanker in the open sea is easy, monetary policy is easy when not much happens. When the oil tanker has to be navigated through some (dire) straits the ultimate test for you theory will come when you hit or do not hit reality (the rocks). So, German policy makers thought that the periphery should have defaulted long ago and that monetary policy is enough to get us out of the crisis.

As a result of the crisis, Alternative für Deutschland, an anti-euro party, sprang up. It is even more anti-government and pro-private sector than the existing parties. That is the price of ignorance that Germans will have to pay. However, the real losses occur in those countries affected by the misguided austerity policies which from the German policy-maker perspective have worked just too well: no inflationary pressures have resulted. The disconnect between policy-makers and reality is breathtaking.

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