{"id":9045,"date":"2021-09-24T18:35:08","date_gmt":"2021-09-24T17:35:08","guid":{"rendered":"https:\/\/progressiveeconomyforum.com\/development\/?p=9045"},"modified":"2021-09-24T18:37:40","modified_gmt":"2021-09-24T17:37:40","slug":"where-has-all-the-money-gone","status":"publish","type":"post","link":"https:\/\/progressiveeconomyforum.com\/development\/blog\/where-has-all-the-money-gone\/","title":{"rendered":"Where Has All the Money Gone?"},"content":{"rendered":"\n

Quantitative easing risks generating its own boom-and-bust cycles, and can thus be seen as an example of state-created financial instability. Governments must now abandon the fiction that central banks create money independently from government, and must themselves spend the money created at their behest.<\/em><\/p>\n\n\n\n

LONDON \u2013 Amid all the talk of when and how to end or reverse quantitative easing (QE), one question is almost never discussed: Why have central banks\u2019 massive doses of bond purchases in Europe and the United States since 2009 had so little effect on the general price level?0<\/p>\n\n\n\n

Between 2009 and 2019, the Bank of England injected \u00a3425 billion<\/a> ($588 billion) \u2013 about 22.5% of the United Kingdom\u2019s 2012 GDP \u2013 into the UK economy. This was aimed at pushing up inflation to the BOE\u2019s mandated medium-term target of 2%, from a low of just 1.1% in 2009<\/a>. But after ten years of QE, inflation was below its 2009 level, despite the fact that house and stock-market prices were booming, and GDP growth had not recovered<\/a> to its pre-crisis trend rate.<\/p>\n\n\n\n

Since the start of the COVID-19 pandemic in March 2020, the BOE has bought an additional \u00a3450 billion worth of UK government bonds, bringing the total to \u00a3875 billion, or 40% of current GDP. The effects on inflation and output of this second round of QE are yet to be felt, but asset prices have again increased markedly.<\/p>\n\n\n\n

A plausible generalization is that increasing the quantity of money through QE gives a big temporary boost to the prices of housing and financial securities, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth trickles through to the real economy, but most of it simply circulates within the financial system.<\/p>\n\n\n\n

The standard Keynesian argument, derived from John Maynard Keynes\u2019s General Theory,<\/em> is that any economic collapse, whatever its cause, leads to a large increase in cash hoarding. Money flows into reserves, and saving goes up, while spending goes down. This is why Keynes argued that economic stimulus following a collapse should be carried out by fiscal rather than monetary policy. Government has to be the \u201cspender of last resort\u201d to ensure that new money is used on production instead of being hoarded.<\/p>\n\n\n\n

But in his Treatise on Money<\/em>, Keynes provided a more realistic account based on the \u201cspeculative demand for money.\u201d During a sharp economic downturn, he argued, money is not necessarily hoarded, but flows from \u201cindustrial\u201d to \u201cfinancial\u201d circulation. Money in industrial circulation supports the normal processes of producing output, but in financial circulation it is used for \u201cthe business of holding and exchanging existing titles to wealth, including stock exchange and money market transactions.\u201d A depression is marked by a transfer of money from industrial to financial circulation \u2013 from investment to speculation.<\/p>\n\n\n\n

So, the reason why QE has had hardly any effect on the general price level may be that a large part of the new money has fueled asset speculation, thus creating financial bubbles, while prices and output as a whole remained stable.<\/p>\n\n\n\n

One implication of this is that QE generates its own boom-and-bust cycles. Unlike orthodox Keynesians, who believed that crises were brought on by some external shock, the economist Hyman Minsky thought that the economic system could generate shocks through its own internal dynamics. Bank lending, Minsky argued, goes through three degenerative stages, which he dubbed hedge, speculation, and Ponzi. At first, the borrower\u2019s income needs to be sufficient to repay both the principal and interest on a loan. Then, it needs to be high enough to meet only the interest payments. And in the final stage, finance simply becomes a gamble that asset prices will rise enough to cover the lending. When the inevitable reversal of asset prices produces a crash, the increase in paper wealth vanishes, dragging down the real economy in its wake.<\/p>\n\n\n\n

Minsky would thus view QE as an example of state-created financial instability. Today, there are already clear signs of mortgage-market excesses. UK house prices increased by 10.2%<\/a> in the year to March 2021, the highest rate of growth since August 2007, while indices of overvaluation in the US housing market are \u201cflashing bright red<\/a>.\u201d And an econometric study (so far unpublished) by Sandhya Krishnan of the Desai Academy of Economics in Mumbai shows no relationship between asset prices and goods prices in the UK and the US between 2000 and 2016.<\/p>\n\n\n\n

So, it is hardly surprising that, in its February 2021 forecast, the BOE\u2019s Monetary Policy Committee estimated that there was a one-third chance<\/a> of UK inflation falling below 0% or rising above 4% in the next few years. This relatively wide range partly reflects uncertainty about the future course of the pandemic, but also a more basic uncertainty about the effects of QE itself.<\/p>\n\n\n\n

In Margaret Atwood\u2019s futuristic 2003 novel Oryx and Crake<\/em><\/a>, HelthWyzer, a drug development center that manufactures premium-brand vitamin pills, inserts a virus randomly into its pills, hoping to profit from the sale of both the pills and the antidote it has developed for the virus. The best type of diseases \u201cfrom a business point of view,\u201d explains Crake, a mad scientist, \u201cwould be those that cause lingering illness […] the patient would either get well or die just before all of his or her money runs out. It\u2019s a fine calculation.\u201d<\/p>\n\n\n\n

With QE, we have invented a wonder drug that cures the macroeconomic diseases it causes. That is why questions about the timing of its withdrawal are such \u201cfine calculations.\u201d<\/p>\n\n\n\n

But the antidote is staring us in the face. First, governments must abandon the fiction<\/a> that central banks create money independently from government. Second, they must themselves spend the money created at their behest. For example, governments should not hoard the furlough funds that are set to be withdrawn as economic activity picks up, but instead use them to create public-sector jobs.<\/p>\n\n\n\n

Doing this will bring about a recovery without creating financial instability. It is the only way to wean ourselves off our decade-long addiction to QE.<\/p>\n\n\n\n


Robert Skidelsky<\/strong>
<\/p>\n","protected":false},"excerpt":{"rendered":"

Quantitative easing risks generating its own boom-and-bust cycles, and can thus be seen as an example of state-created financial instability. Governments must abandon the fiction that central banks create money independently from government, and must themselves spend the money created at their 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