Eurozone M3 – at one time supposed to be the lodestar of the European Central Bank’s monetary policy decisions – has barely changed for 11 months. (More precisely, it was 9,400b. euros in October 2008 and 9,415b. euros in September 2009, giving an annualised growth rate of under ¼%.) Moreover, despite ECB economists’ traditional commitment to M3 as one of “the pillars” of their orthodoxy, official policy statements show that the ECB plans to do nothing specific to raise money growth. In fact, the representatives of Bundesbank orthodoxy most involved in Eurozone policy- making (such as Jurgen Stark, the ECB’s chief economist, and Bundesbank president, Axel Weber) have both
- rejected suggestions that the ECB buy long-dated government bonds from non-banks to boost money growth (e., a UK-style programme of “quantitative easing”), and
- opposed demands from hard-pressed smaller countries for a less well-defined policy easing of some sort.
Has the UK’s “quantitative easing” been a success or failure? And should it be dropped, continued or expanded? With base rates virtually as low as they can go and therefore no longer effective as an instrument to boost the economy, the Monetary Policy Committee’s views on QE have become a central talking point. The MPC was widely expected at its latest meeting (8th and 9th July) to announce that it would now use up (in July and August) the £25b. last leg of £150b. of asset purchases originally envisaged, but it declined to do so. This week’s e-mail – which borrows loosely from my article in yesterday’s (9th July’s) Financial Times – argues that, since its introduction in March, QE has rescued the UK economy from a debt-deflationary disaster. If QE has disappointed so far, the main reason is that the deflationary forces at work by February 2009 were extremely powerful. The £150b. programme of asset purchases was enormous, but it was not enough decisively to overwhelm these forces. The Bank of England needs to continue with QE, and probably to raise the total of asset purchases towards the £200b. - £250b. area.
Worries about inflation are misplaced – indeed extraordinarily misplaced – in current conditions. Output is further beneath trend in the major advanced economies than at any time in the post-war period. Rising inflation will not return until after a global boom or an extended period of above-trend growth. Nevertheless, Mr. Alan Greenspan – the revered former chairman of the US Federal Reserve – published an article in the Financial Times of 26th June under the title ‘Inflation is the big threat to sustained recovery’. The argument of this note is that Greenspan is seeing ghosts. There is little or no risk of a significant rise in inflation until after – probably several quarters or even years after – output has returned to its trend level. The main point is simple (and is indeed much the same as in our weekly e-mail of 22nd May), that on average inflation has fallen during US recoveries. Just to reiterate the fundamental point being stated here, typically in the recovery phase of an American business cycle falls in inflation accompany above-trend growth. Within the space allotted by the Financial Times, Greenspan was hardly able to develop a meaningful economic model. He reported that, “annual price inflation in the US is significantly correlated (with a 3 ½ - year lag) with annual changes in money supply per unit of capacity”. If Greenspan were referring here to M2 or M3 per unit of output, his claim would be both understandable and backed by a large amount of evidence over many decades. But had he not noticed that so far in 2009 M2 growth has decelerated sharply compared with 2008? (See our weekly e-mail of 11th June on "US M2 – The Bernanke flip-flop".) Greenspan then highlighted the USA’s large budget deficit and the danger that it might be monetized, with eventual inflationary consequences. There are two problems with this argument.
Many participants in financial markets are apparently sceptical that QE will do much good to the economy. Why, they ask, should quantitative easing work in the UK in 2009 (and perhaps in 2010, if it continues) if it failed in Japan between 2001 and 2006? In this article I will show that UK-style QE in 2009 is very different from Japan-style QE in the 2001 – 06 period. Relative to the UK’s smaller economy, the Bank of England’s QE is much bigger and more compressed in time. The larger point is that, in the economy threatened by a “debt deflation” process, the state (i.e., the government and central bank, ideally working together) should create new money balances in order to boost asset prices and demand. (I set out the argument in a pamphlet on How to Stop the Recession published earlier this year.) QE is nothing more nor less than the creation of new money balances by the state to prevent deflation. Please contact me ([email protected]) if you would like a copy of How to Stop the Recession.