Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 31 December 2014

On the Stupidity of Demand Deficient Stagnation

In my last post I wrote about “why recessions caused by demand deficiency when inflation is below target are such a scandalous waste. It is a problem that can be easily solved, with lots of winners and no losers. The only reason that this is not obvious to more people is that we have created an institutional divorce between monetary and fiscal policy that obscures that truth.” I suspect I often write stuff that is meaningful to me as a write it but appears obtuse to readers. So this post spells out what I meant.

First a preliminary. If you do not understand why economies can suffer from deficient demand, and why this is a needless waste of resources, then to be honest your best bet is to read a few chapters of a popular book on macro, like Tim Harford’s latest. If you have done a macro course and do not believe prolonged demand deficiency is possible, just tell me how you get out of a liquidity trap in a world with inflation targets after reading this post (and maybe this).

Demand deficiency when inflation is persistently below target (the stagnation of the title) should not occur, because it is easy to solve technically. If I was a benevolent dictator in charge of both monetary and fiscal policy instruments, stagnation would never persist in my economy. The way I would ensure this most of the time is by varying interest rates, but if nominal interest rates hit zero (a liquidity trap) I have a whole range of alternative instruments, ranging from cutting various taxes to increasing transfers or raising public spending. I know of no macroeconomic theory on earth which tells me that everyone of these instruments will fail to raise demand.

Whatever instrument I use to raise demand in a liquidity trap, I need to finance it. I can do this by issuing bonds (increasing government debt) or creating money. A higher stock of government debt or money is the only legacy (apart from happier people) of my successful operation to remove demand deficiency. We generally prefer governments to use bond finance, for reasons I will come to. But supposing there is some constraint (real or imagined) on issuing bonds. As a benevolent dictator I can just create money, which we call money financed fiscal stimulus. Money financed fiscal stimulus is a sure way of ending demand deficiency in a liquidity trap.

If that higher stock of money proves too great later on when the economy has recovered, I can reduce it by various means. There will be no subsequent above target inflation. There are no technical problems that I as a benevolent dictator need to worry about here. Of course creating lots of money on a temporary basis is exactly what central banks in the UK, US and Japan have recently done (QE - Quantitative Easing). The problem is that they have not been accompanied by sufficient tax cuts, increased transfers or increased government spending. Creating money to buy financial assets is by comparison to money financed fiscal stimulus an unreliable way of raising demand.

So that is it. Demand deficient stagnation is easy to prevent technically. The huge waste of resources that we see in the long and incomplete US recovery, the even slower UK recovery and the absence of recovery in the Eurozone are all unnecessary, because we know how to fix them. [1]

What stops this happening in the real world is that we have become fixated by the labels ‘monetary’ and ‘fiscal’ policy, and created an independent institution to handle the former. Central banks do monetary policy (varying interest rates and creating money) but are not allowed to give money directly to the people (helicopter money, or John Muellbauer’s QE for the people). Governments run fiscal policy, so can do bond financed fiscal stimulus, but are not allowed to create money. So a self-imposed institutional setup prevents either central banks or governments doing money financed fiscal stimulus alone.

A major reason why this institutional arrangement exists is to discourage non-benevolent governments creating inflation through fiscal profligacy, or more recently in order to increase policy credibility. Of course during a period of stagnation there is no danger of rampant inflation. Unfortunately this institutional arrangement creates a problem when governments – in my view for largely imaginary reasons - put a priority on reducing deficits. Money financed fiscal stimulus is not available to get you out of a liquidity trap. So we get this huge waste of resources.

Within the existing institutional framework, there is plenty to be done to convince fiscal policy makers that reducing deficits should not be a priority in the short term, or in trying to improve the monetary policy framework so liquidity traps happen less often. Yet it would be better still if we had an institutional framework which was a little more robust to failures on either front. We need to regain the possibility of money financed fiscal stimulus in a liquidity trap.

[1] What I say here has a lot in common with the advocates of Modern Monetary Theory. However, it also appears to be perfectly standard macroeconomics to me, so here I will simply commend them for highlighting these aspects of mainstream thought. 


  1. This post was very necessary in view of your extremely odd previous one.

    Unfortunately, you require

    - a dictator that shares your views

    - central banks that are not independent

    and unbounded optimism

    1. Why would “money financed fiscal deficits” require a dictator? All that’s needed is some sort of committee of independent economists (much like the BoE MPC) that decides on how much of the above type of stimulus is appropriate. Members of such a committee would not be VOTED into office by the plebs, so to that extent that’s “undemocratic”. They’d be appointed on the basis of technical qualifications, experience, etc. But then members of the MPC have a big say on stimulus, and THEY AREN’T voted into office by the plebs. So no change there.

      As to the EXACT FORM that any additional stimulus spending would take, that’s clearly a political decision, and there’s no reason for that decision to be taken away from the electorate and politicians. I.e. the committee would announce that £Xbn of extra spending is needed in the next 6 months, then it would be left to politicians to decide on what form that spending or tax cut would take.

      Re your point that central banks would no longer be independent, what’s the problem there? Simon’s proposal in effect means merging (or at least merging some functions of) central banks and treasuries. I can’t see the problem.

    2. Indeed, no change there.

      Which is what the MPC is grotesque in democratic terms.

      It is no good saying it is set up by democratic process and therefore fine. Hitler's dictatorship was also voted into being using an impeccable democratic process.

    3. Spinning H,

      MPC grotesque? Yes, lots of people who previously had no objections to the MPC are now suddenly claiming it’s the Devil incarnate. The explanation for this volte face is all too obvious (though if you’ve previously accused the MPC of being the devil incarnate, then that point obviously doesn’t apply to you).

      Anyway, I’m baffled as to what’s wrong with putting TECHNICAL decisions into the hands to TECHNICALLY QUALIFED committees. Obviously politicians always have the ultimate say, but do you really think the economically illiterate Milliband or Cameron are qualified to measure inflation and judge how much stimulus is suitable? What other technical decisions do you want M&C to take? Designing nuclear power stations… how best to do brain surgery?

    4. "central banks that are not independent"

      Central banks are not independent. They are the government's bank first, banker to banks, second. If the government's policy was fiscal expansion financed by printing money, it would have to do what it is told. It has to keep an even keel in the money markets, sure, but that is part of its role of ensuring the effective execution of the goverment's macro programme.

    5. Ralph,
      The folly of your preferred approach is exemplified by the euro area.

      First, the rules set up, however benign in intent, will always hit an unforeseen situation where they operate badly. They are then hard to change when speed may be essential.

      Second, the problem with economic decisions being taken by unelected bodies isshown by Greece. If decisions are not democratically mandated, those who lose out dont accept them. See the rise of Syrzia following loss of control to the troika.

      There were good reasons why previous governments, of all political shades, did not do what Brown did in handing monetary policy over to the technocrats. I dont want decisions of this kind made by people like Blanchfliwer., who is not my idea of a nuclear scientist. The objections were not economic ones, which is probably why economists ignore them.

    6. Spinning H,

      On second thoughts, aren’t we all making a bit mistake here..?.. The question as to what powers should be given to committees of technicians relative to the powers given to politicians is ENTIRELY separate from the question as to whether stimulus should take the form “money financed fiscal stimulus” or whether it should take the form of traditional fiscal policy, traditional monetary policy, QE or whatever.

      That is, money financed fiscal stimulus can work in a regime where politicians are all powerful, and it can work in a regime where committees of technicians are all powerful.

      Another stray thought: money financed fiscal stimulus was advocated by Richard Werner (economics prof in Southampton) and co-authors in their submission to the Vickers commission. See bottom of p.10 onwards at the link below. (Werner actually advocated sort of split of powers as between politicians and technocrats that I favour. But like I say, that split is easily varied.)

    7. Well, what matters of course is getting the decision right, not who makes it. So the technocrats can get it wrong (eg the ECB's insane decision to raise rates in 2011) or the politiicans (acting under advisement) can get it right (eg Labour fiscal policy from 1997-2005, the point at which S W-L's favourite wrested control from Blair).

      The problem in the ez is that all roads looked closed off. So, fiscal stimulus is ruled out by the ez's rules. QE is unlawful. Helicopter money by the ECB is unlawful, and individual member states cannot do it.

      So, unless the ez breaks up (not going to happen) the only way forward I can see is getting agreement to change the rules to allow concerted fiscal stimulus, combined with pressure from the other member states on Germany for it to have a period of higher inflation.

      There is I suppose an argument to be made that the half way house we currently enjoy (fiscal policy in the hands of the politicians, monetary policy the technocrats) is the worst of all possible worlds, particularly at European level. Taking monetary policy out of the hands of elected politician's allows them to pass the buck ("it is the ECB's fault"), whilst the technocrats at the zlb lack all power to do anything. It certainly leaves open the possibility of economic policy being uncoordinated, especially in a quasi-federal system like the ez.

      So, I agree with S W-L. The problem is structural.

    8. I mostly agree but for one thing. Individual eurozone members can issue helicopter money, via tax credit certificates. And they should, asap. A eurozone breakup is a real possibility. Politically, the southern eurozone situation is getting unsustainable. Economically, it's a crazy nightmare.

    9. Looks to me like that is just another form of state backed currency: prohibited by the euro's rules. it isn't a tax rebate (as tradeable) nor is it just a bank deposit. Calling it 'quasi-money' doesn't really help.

      You need to change the rules. Hard to do, once agreed upon.

    10. Hard to do ? Not at all. Current rules are just unenforceable.

    11. SpinningH31 December 2014 at 08:10

      Why in the world should Germany have a period of higher inflation? Even if you consider concerted fiscal stimulus necessary it does not follow.

  2. So, more benevolent dictators, and less democracy then?

    In your last post you complained about the ECB not employing helicopter money, but the reason they cannot is that it is unlawful for them to do so. Those pesky democrats not having given these particular benevolent dictators the power to do so.

    We could of course take the levers of economic power completely away from the democratically elected representatives, as effectively we have done with monetary policy, and give the lot to (a?)benign dictator(s?), perhaps constrained by some rules set up by even wiser and more benign dictators above them (employed at one of the better universities?).

    For some the reduction in human misery that this benevolent state of affairs would lead to would be a price well worth paying.

    For others (eg me) all economic decisions are normative (or, if you prefer, ideological). Facts alone cannot give you an answer. To take a concrete example, it would be quite wrong for the ECB to decide who gets how much helicopter money. This is an exemplar of a political question of distribution which can only be resolved by someone with a democratic mandate. T

    That means the technocrats can advise but not decide. We should stick with representative democracy, for all its flaws, whilst allowing the technocrats to shout as loud and long as they can (unfortunately rarely speaking with one voice) when they think the politicians are cocking everything up.

    The technocrats who were not shouting quite so loudly at the time of the euro's rules being set up are of course deserving of a bit of criticism (yes, I do know some were critical, but if the claim is that the profession spoke with one voice my memory is playing me tricks). As we have established in relation to other topics, it is all very well being wise after the event, much better to draw attention to what the impact will be at the time the decision is made.

    1. I think I’ve answered all your points in my response to Anonymous above, but at pain of repeating myself…..

      You say, “We could of course take the levers of economic power completely away from the democratically elected representatives…” So far as determining the amount of stimulus goes, we’ve ALREADY very largely taken those powers away from democratically elected representatives. E.g. far as interest rate adjustments and QE goes, that’s in the hands of the BoE MPC, which is not “democratically elected”. As to fiscal stimulus, decisions there in recent years have been partially handed to committees of economists, e.g. the OBR in the case of the UK.

      Next, you say “…it would be quite wrong for the ECB to decide who gets how much helicopter money.” Agreed. But the fact of the ECB deciding that Xbillion of helicopter handouts is needed, does not mean the ECB has to decide exactly who gets the handouts. As I pointed out above, that can be, and indeed should be left to elected politicians.

    2. Your paragraph that starts, "What stops this happening in the real world is that we have become fixated by the labels ‘monetary’ and ‘fiscal’ policy". It is fundamentally erroneous!

      Governments do not have to do bond financed stimulus. There is no operational requirement for the government to issue, so called, debt instruments at all, it chooses to do so. It is a throw back to the Gold standard. The Treasury creates new money by simply spending it into existence "from thin air" with a keyboard. It will put it back into thin air with taxes when there is too much of it in the economy chasing too few available goods and services (inflation control). If you are unfortunate enough to get a "deficit hawk" for a chancellor, he will take far too much out of the economy (reduced spending and increased taxes), and slow the economy to a crawl. All in the cause of some knackered old neo-liberal ideological myth.

      Likewise, the central bank does not create new money (increase the financial assets in the economy), it can only swap one type for another. QE is a maturity swap operation to zero maturity "reserves" (cash).

      I would respectfully suggest that you have a read of Randall Wray because there is a lot of basic misunderstanding of how a sovereign fiat currency economy actually operates.

    3. "Anyway, I’m baffled as to what’s wrong with putting TECHNICAL decisions into the hands to TECHNICALLY QUALIFED committees. Obviously politicians always have the ultimate say, but do you really think the economically illiterate Milliband or Cameron are qualified to measure inflation and judge how much stimulus is suitable? What other technical decisions do you want M&C to take? Designing nuclear power stations… how best to do brain surgery?"

      We heard this sort of nonsense during the Scottish Referendum. The issue have to be understood by the public and can be if properly explained. (The only thing made difficult about macro is a lot of unnecessary abstraction to make way for mathematics in a confused belief that somehow this associated with being more scientific. We make even bigger decisions than economic policy - eg, going to war. And we do not leave such things in the hands of committees.

    4. Ralph is an economist. They are renown for having psychopathic tendencies and a lack of empathy. Of course they think they can rule the world better than ordinary elected MPs.

      The definition of 'expert' is probably pertinent. Ex being somebody who is past it, and a spurt being a drip under pressure.

      The problem with 'experts' is they have a terrible tendency to be completely wrong - particularly in areas where you can't experiment easily to prove things one way or another.

      Want another example. Try the diet 'experts' who after years of telling us that fat was the number 1 enemy have now changed their minds and decided sugar is the number 1 enemy. Exactly the same problem as economics - selective data analysis to curve fit to a pre-held belief.

      650 elected MPs can take advice from whoever they choose, including self proclaimed economic experts if they want to. Then they decide in parliament and if they turn out to be wrong, the people will boot them out and replace them with the other lot.

      Unlike Mervyn King who stayed in post until he retired and is still convinced he saved the world.

    5. Neil,

      If everyone who is happy with the BoE MPC’s current powers is psychotic, then the country is awash with psychotics: I’d guess a good 75% of the economics profession, most Financial Times readers, etc etc. There probably aren’t enough funny farms in the World to treat us all. But any suggestions you have as to where we can all go for psychiatric treatment will be appreciated.

  3. In principle I mostly agree with you but in our current situation in the UK or USA or Japan I'm not sure that the blame can be pinned on independent central banks. The eurozone PIIGS are different but Germany, Netherlands etc also don't have the bond markets exerting any sort of a restriction on fiscal policy at the moment do they? The incredibly low (zero or negative) treasury bill rates show that the lack of fiscal stimulus is not because the central banks aren't providing the means. It doesn't take that much QE to peg interest rates as low as you like does it? WWII was financed with bond finance with just enough central bank bond purchasing to keep yields pegged as low as needed. That require central bank coordination but it didn't require a wholesale switch to money financing (not that that would make much difference IMO).

    The only way you could say central bank independence is now a problem would be if you believed the market monetarists' claim that even more QE could now somehow further "loosen" things. Do you believe that? If so please explain it because I've struggled a lot and failed to follow their claim.

    I think this is really about the stagnation being due to an overconcentration of financial claims and prosperity requiring broad based economic power. That's a political issue. To solve it would require some level of relinquishing of relative financial power. The 2008 bail-outs show that the full power of the state will do what it takes to prevent that from happening.

    1. Is the post based on the idea that governments would somehow be less reticent about deficit spending if it were money financed than if it were bond financed (even with negative T-bill yields and central banks that were commited to ZIRP)?

      If so why? This also seems like a market monetarist type idea that money is mystically special and so isn't just another debt security -even when there is such a glut of money that it no longer commands any premium over T-bills.

    2. Money is mystically special. It is involved in half of all transactions.

  4. Another excellent post, but no doubt the clueless idealogues and occasional trolls who provide the entertainment in the comments on here will still find a way to misinterpret, misunderstand and misrepresent you and the very basic macro described.
    However, you are living in fantasy world when you write "...your best bet is to read a few chapters of a popular book on macro, like Tim Harford’s latest."
    Read a book on macro to grasp the basics?? You know that this is just a pipe-dream and that they would never do this!
    Whatever next? You'll be recommending they consider using evidence and data to support their claims!!
    Keep up the outstanding work and a Happy New Year!

    1. I can only speek for myself, but I'm commenting on here in an honest effort to get my head around the subject. I've found to-and-fro interactions to have clarified things for me. Often what seemed with hindsite to have been somewhat stupid comments have nonetheless exposed misunderstandings that were then sorted. So perhaps don't be so sniffy about peoples' comments.

    2. I assure you - and should have clarified - that genuine, enquiring comments, including those that don't necessarily agree with the host or anyone else, but are explained logically with reference to actual observations and supported by reputable, robust studies and evidence should, as you say, always be welcomed and indeed help to clarify matters.
      In a nutshell I was refering to those on here who write with a distinct undercurrent of attack and incredibly with a tone of higher authority (over SWL) in their narrative - 'incredibly' because they make the most basic macro errors/misinterpretations and misunderstandings, ignore data/evidence with disproves their views, never cite relevanct evidence to support their views, and as such have very limited knowledge of even basic macro. Yet somehow they have the confidence to continously 'correct' SWL, a professor of economics, even though they clearly have never read a basic macro textbook, and nothing will change their mind or write and honest comment or question seeking clarification or stating that they don't understand something...even when their comments show they have no clue. As I said originally, I was referring to the
      "clueless idealogues and occasional trolls" - who know who they are, rather than the majority of genuinely enquiring minds such as yourself.

    3. Simon, I still don't think you are right to be quite so quick to identify people as being wantonly "clueless idealogues and occasional trolls". Its reassuring that I didn't come across that way to you but you seemed to be saying that people ought to just shut up and rote learn the standard macro text books. Economics is a very weird field in that there are very very divergent views within it and sadly none of them can claim much of an evidence base as far as I can see. Everyone thinks they are right or otherwise they would think differently. You could put together a bunch of Economics Professors such as say Michael Hudson, Scott Sumner, Bill Mitchell and Greg Mankiw and I fear the discussion would seem like the ultimate clash of the trolls. I agree that people should always be polite and respectful but you don't seem to adequately appreciate that people genuinely see things differently. I wish more of an effort was made to try and build an evidence base to sort out what is insight and what is nonsense but as far as I can see there is zero enthusiasm for any effective program of testing such as used by weather forecasters. Weather forecasters test their forecasts against many many different locations all the time. Its comprehensive and rigorous. They care about predicting very rare events such as severe storms hitting land. Economists just seem to want to avoid exposing their pet theories to a genuine test. Sorry if that seems mean and disrespectful but that's how it comes across to me.

    4. I agree with stone here. I learned economics to masters level after a scientific education to PhD level, and I have always found the "basic" macro textbooks unrigorous by my standards (eg concepts like Marginal Propensity to Consume out of, say, income - what happens to the rest of it?), so academics - usually Keynesian ones in my experience - who respond to challenges by saying "this is Econ 101)" sink in my estimation. In my view, the whole methodology of macroeconomics needs to be fundamentally reformed towards a more mechanistic approach (ie I want to understand how it works, whether that can be mathematically modelled or not), but that is another issue.

    5. Stone: To put it mildly I think you've read a little bit too much into my general point, especially the 'rote learn macro books' and 'shut up if you don't agree' straw-man my comments again carefully and you will see this is clearly not what I was advocating at all. In fact almost the opposite:
      "genuine, enquiring comments, including those that don't necessarily agree with the host or anyone else, but are explained logically with reference to actual observations and supported by reputable, robust studies and evidence should, as you say, always be welcomed and indeed help to clarify matters. "

      The above mentioned approach to comments is unfortunately not taken by some commenters at all - (see previous paragraph above starting with "In a nut shell...." for their approach; hence "clueless idealogues and occasional trolls".
      ie. those who make the most basic macro errors (including incorrect definitions of basic terms) - hence the completely valid and appropriate response (yes, usually by more Keynesian economists) of "this is Econ 101" - those who's models have best (though not perfectly of course) described and predicted what's been happening during and since the financial crisis (the ineffectiveness of mon pol at the ZLB, the existence of a liquidity trap, the negative impacts of fiscal consolidation and the non-existent threat of inflation given the size of the output gap over the period. For one more extreme example, read Andrew Lilico's predictions from 2010
      Even at 1st Jan 2014 he was still predicting "By year’s end, CPI inflation will be comfortably above 3%", not to mention his current bet with Jonathan Portes.
      Over the period, you might expect him to revise or change his views or question the 'models' he's using...but no. And yes, reading over his explanations from the above bbc link, Econ 101 would have told him he was wrong to make those predictions. That said, we should not expect perfect predictions, since the economy is such an incredibly dynamic, unpredicable place often influenced by strange human behaviours...etc etc.
      A Happy New Year to you!

    6. The ineffectiveness of monetary policy at the ZLB is debatable. What is QE? Fiscal policy?

    7. Re: "...they make the most basic macro errors/misinterpretations and misunderstandings, ignore data/evidence with disproves their views, never cite relevanct evidence to support their views, and as such have very limited knowledge of even basic macro."

      Exhibit 'A': "The ineffectiveness of monetary policy at the ZLB is debatable. What is QE? Fiscal policy?"

      Don't stop the entertainment...

    8. Oh dear. Irony didn't work.
      Most commentators believe QE has been effective. Not great, but effective. QE is monetary policy. We have been at the ZLB. Therefore monetary policy is effective at the ZLB. OK now?

    9. I have never heard an argument that counters what I say here:

    10. Dangerously, continuing with your medical metaphor.

      If the definition of health is a temperature target that actually is believed to be a maximum that is dangerous to go over, then we might have a problem. Human temperatures are fairly steady, but do vary a bit between people and over time, all in a safe bound. Obsessive application of medicine to keep the temperature at or below a long average will have material side-effects. There are also many other measures of health too, heart rate, obesity, malnourishment, cholesterol, etc, etc. Over focus on and treatment of one element is not likely to be helpful either.

      A 2% inflation target is the wrong goal, too rigid and too low and with little scientific backing. Much better is a flexible inflation target, better still NGDPLT, taking into account both RGDP and inflation in one swoop, while admitting uncertainty about the balance.

      And interest rates are not the only medicine. In fact, they are not even a medicine, expectations about future interest rates are the medicine.

    11. And Scott Sumner did reply to the John Williams paper you cite as support for your view.
      Essentially saying the same thing as me. Obsession on IT led the Fed to miss the bigger picture of crashing NGDP expectations, causing the collapse in AD.

    12. As I said, I've never heard a counter to the argument that QE is too uncertain an instrument relative to conventional monetary and fiscal policy, and therefore the ZLB does matter.

    13. As I have said, I am still waiting for you to explain:
      1. Your optimism over the effectiveness of G. Most academics love government, you are no exception. The rest of us are more sceptical. Either way it is a very live debate about "the value for money" of G.
      2. Why you think it is so straightforward to combine fiscal and monetary policy under one authority. All I see is endless debate about it.

      There is nothing conventional about the counter-cyclical fiscal spending policy you constantly campaign for. If there was, it would be the policy.

      If the results of "conventional" monetary policy were certain we'd now be in a glorious recovery. But, as you rightly show in your next post, we aren't. So much for "conventional" monetary policy. Why one test for conventional monetary policy and another test for NGDPLT?

    14. 1. Try reading this blog.
      2. Try reading this post.
      3. Try reading my latest post.
      And more generally try using your comments to address the questions in an open minded manner, rather than treat it as some kind of school debate.

    15. But following 1, 2 & 3 and the "more generally..." advice might mean no more incoherent yet entertaining comments!
      Note: When people talk about 'monetary policy', the phrase is generally given to refer to 'conventional' monetary policy of course, given the unusualness and rarity of the use of 'unconventional' monetary policy...QE.
      Hence "the ineffectiveness of mon pol at the ZLB" of course refers to conventional mon pol. Defining mon pol as referring to both conventional and unconventional methods such as QE is completely inappropriate in the context of a discussion on the liquidity trap, and rather presumptious (and incorrect) to think that I meant QE had been ineffective, when I don't. So rather than the juvenile 'gotcha!' approach to comments, why not ask me if I had meant QE had been ineffective at the ZLB?

  5. I very much liked the article but have a question.

    Even at the ZLB there are lots of financial assets that have non-zero interest rates because they carry a risk premium. If the CB buys up these assets and reduces their return then this will encourage present consumption over future consumption in just the same way that buying risk-free assets does when the risk-free interest rates is above zero. This would seem to be the case irrespective of whether these purchases are seen as leading to temporary or permanent increases in the money supply.

    Given this, why at the ZLB is "helicopter money" seen as preferable to QE-type activities that involve the purchases of assets who have a risk premium and whose interest rates aren't at zero ? Both would seem likely to work , but QE has the advantage of being easier to reverse out when needed and have less of a "distributional" effect on the economy.

    Why is

    1. Is there really any truth in the idea that QE buying assets will "encourage present consumption over future consumption"? Doesn't it simply mean that cash becomes a more preponderant asset class for wealth holders? If you were managing an insurance company or a pension fund or whatever and there was a huge QE program, what would you do? My impression is that what gets done is they just hold more cash and tough it out.

      Your statement, "the CB buys up these assets and reduces their return" also supposes that CB buying can induce a durable pricing reset for those assets. I think it is one thing for a CB to say peg 10year treasury bonds to a 3% yield and quite another to try and keep say stock or junk bond prices aloft -risk premiums are so messy and hard to gauge. My guess is that a fully fledged stock market crash could take place even into the teeth of a CB stock buying program. The BOJ has done such stock buying haven't they and yet had fairly wild gyrations in stock prices. People will still be scared of buying overpriced stocks for the good reason that they could lose out badly.

      My impression is that the ""distributional" effect on the economy" that you want to avoid is actually itself the only thing that actually has any hope of working. It may be politically unpaletable but that may be something that we need to face up to.

    2. Further to what I was trying to say above, zero yielding cash is by no means a worthless asset class from a wealth management perspective and so by no means necessarily a "hot potato".

      Check this out:-

      "“Ms. Schroeder argues that to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates, said Ms. Schroeder, who followed Mr. Buffett for years before she became his biographer.

      “He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

      It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing.

      Read more: really like the way this article describes how Warren Buffett thinks about cash. I think of it similarly (see below), but I never thought of it as a call option. It says: “Ms. Schroeder argues that to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates, said Ms. Schroeder, who followed Mr. Buffett for years before she became his biographer. “He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.” It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing. Suddenly, an investor’s asset allocation decisions are not simply between earning nothing in cash and earning something in bonds or stocks. The key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”

    3. appologies that the copy and paste above seemed to stick a load of phantom gumph on the end that I hadn't intended to paste.

    4. I agree that especially when interest rates are low cash becomes very attractive to hold. This is consistent with the fact that lots of cash IS currently being held.

      But even with this fact - at the margin some investors will choose to consume rather than save if the interest rates on risky assets falls - and this should enable CBs to use asset purchases to drive increased AD even at the ZLB.

    5. I guess it all boils down to whether the effect would be negligible or plenty large enough. My fear is that it would be negligible.
      I think it is a very big mistake to imagine that wealth holdings are appreciably about people deciding to defer consumption because they want their wealth to earn more to enable more consumption at a later date. Instead they are much more about insurance against whatever uncertainties we face. If your pension fund is expected to do badly, you will save more not less so as to avoid destitution when your old and infirm. I know my pension fund has just insisted on greater contributions for just that reason. For high net worth types it is also all about insurance against possible future calamity. Have you seen this
      "An important but sad reason why our requirement for wealth-as-insurance is insatiable is because insurance is often a zero-sum game. Consider a libertarian Titanic, whose insufficient number of lifeboat seats will be auctioned to the highest bidder in the event of a catastrophe. On such a boat, a passenger’s material needs might easily be satisfied — how many fancy meals and full-body spa massages can one endure in a day? But despite that, one could never be “rich enough”. Even if one’s wealth is millions of times more than would be required to satisfy every material whim for a lifetime of cruising, when the iceberg cometh, you must either be in a top wealth quantile or die a cold, salty death. The marginal consumption value of passenger wealth declines rapidly, but the marginal insurance value of an extra dollar remains high, because it represents a material advantage in a fierce zero-sum competition. It is not enough to be wealthy, you must be much wealthier than most of your shipmates in order to rest easy. Some individuals may achieve a safe lead, but, in aggregate, demand for wealth will remain high even if every passenger is so rich their consumption desires are fully sated forever."

    6. Market Fiscalist,

      To answer your question, helicopter money is preferable to QE because the former increases what MMTers call the private sector’s “net financial assets”: that’s base money and government debt. In contrast, QE doesn’t increase NFA. Ergo helicoptering should have a bigger effect per dollar.

      Your point that helicoptering is difficult to reverse is a good one: certainly cutting the state pension and other benefits might cause riots. On the other hand, the UK government upped VAT recently and no one turned a hair. Raising income tax wouldn’t cause riots. Thus if a quick and substantial reversal is needed, hopefully a combination of increased interest rates, VAT and income tax would do the trick. Basically I don't favor interest rate adjustments, but don't object to them as an emergency measure if there is no better alternative.

    7. Ralph Musgrave, do you really think that the overall stock of net financial assets is what matters rather than distributional effects? Let's imagine that a central bank were to conduct a helicopter drop that was modified so as to appease the Koch brothers or whatever. So as to compensate wealth holders for the increased risk they would suffer from a helicopter drop, money would be doled out strictly on the basis that only those who already had at least £10M net worth would be given a helicopter drop to double their net worth. That would increase net financial assets very well but I'm not at all sure that it would do much to shift the economy out of stagnation.

    8. I also think it is worth looking at historical examples of helicopter drops that were successful. The 1948 "currency reform" that brought about the Wirtschaftwunder in Germany entailed both a dole out of Deutsche Marks at 60DM per person and to businesses at 60DM per employee but ALSO a vast write down of the Reichsmark financial assets. It certainly did not increase private sector net financial assets overall. It was at least as much a confiscation as it was a giveaway.

    9. Stone,

      I didn’t say or imply that distributional effects were unimportant. Indeed I fully agree with “Rob Sol” below who advocates giving helicopter money to Main Street rather than to the rich / Wall Street.

      My point was that all else equal, helicoptering has more effect per dollar than QE.

      As to Germany immediately after WWII, Germany’s economy at that time was in a very strange situation which doesn’t make it much of a guide as to what to do today. But in any case, if there were factors in Germany then that helped bring about the Wirtschaftwunder other than increasing the private sector’s net financial assets (and I’m sure there were) that in no way detracts from my above point, which to repeat, was that all else equal, helicoptering has more effect per dollar than QE.

    10. Ralph Musgrave, I'm basically agreeing with you that helicoptering has more effect than QE and I'm reassured that you also think distributional effects are important. I guess I was just trying to say that perhaps the distributional effects are all there is to it and that the overall stock of net financial assets might be a red herring.

  6. I understand your essay, but I'm becoming a little skeptical about providing tax cuts in our current situation here in the US. We have plenty of idle cash or cash equivalents sitting in a small number of bank accounts. This money is not being invested or consumed. It has, in fact, been removed from the economy. Giving the owners of these assets a tax cut will provide zero stimulus. In my view, it would be much better to raise taxes on these accounts, and spend most if not all of this tax revenue on infrastructure projects of size. Broad based tax cuts, in my opinion, have no focus; they are undifferentiated and economically speaking impotent. We halved the social security tax, for example, as part of the stimulus package and I don't think anyone knew they had their taxes reduced!
    Buying a better brand of Scotch doesn't sound to me like a very smart way to stimulate an economy.

    1. Giving tax cuts to poor people will work; giving tax cuts to rich people will probably lead to more saving. In general, we need more saving in the US but now is not the best time. Best to lower the SS tax which will increase the incentive to work and put money in the hand of workers.

  7. Sorry to be late to this, but it seems obvious the next step should be calculating ROI for financing demand.

    As a low brain power stab at it, if GAP equals the below trend deficiency, then we can invest in GAP units to bring demand back up. One GAP will bring GDP back to trend, but may not be sufficient for private spending to recover trend, so more GAP each year would be required. Over some time period of financing, private spending would reach trend. Total investment would be GAP times time to trend.

    Meanwhile, the returns would be GAP times multipliers, times duration, and the duration could be quite long, making for a gigantic PV.

    It would seem then that ROI must be on the order of many 100's of percent. Which makes a politics that refuses to make such an investment idiotic. Perhaps demands an examination of legitimacy, too.

  8. So, to put it on a dinner table napkin, vertically you have the interest rate with zero at the base. On the horizontal axis, at the two opposite ends of a bell curve are monetary and fiscal policy. This curve demonstrates that restricting policy to one extreme or the other keeps interest rates at zero. Mixing the two policy subdivisions moves the interest rates towards increasing levels of optimization.

    Congratulations economist guy. You've transformed the Laffer Curve into something describing our current dilemma.

  9. The unnecessary suffering caused by this is very sad. It's all very true but I think a more convincing case could be made for those who see fiscal stimulus as irresponsible government spending.

    The tax cuts form of stimulus does half the job of convincing the small government crowd. The only problem is that tax cuts don't work as well if the money ends up idle in bank accounts when conditions are such that the money multiplier is low (and for that matter government spending does better but not that good either). It can all seem futile. The only real solution is to boost the multiplier using higher inflation targets. Now I don't know if something like NGDPLT is the solution, but it is clear to me that without temporarily higher inflation targets, the safe, short term investment opportunities, those that have a real return lower than -2% are priced out of the market by fiat money.

    Yes you can replace these investments by government spending without higher inflation targets but you will need a lot of spending if the multiplier is not on your side. If the spending is not sufficiently on long lasting things that will be needed later, it amounts to forcing people's investment spending into consumption spending. This aspect, I think, bothers those who believe it is good to save for later and could affect negatively an economy with a large baby boom about to retire that want to be able to rely on having a certain standard of living when they no longer work.

    There is a common ground between the Keynesians and the Market Monetarist that consist of raising the inflation targets, at least temporarily, to let the labor and investment markets clear and also do some fiscal stimulus to allow the money to flow more readily and allow the economy to reach its targets more confidently so we don't rely only on MM expectation mechanisms. Why can't economists agree on the common ground and move in this direction? Why not put differences aside? Europe desperately needs saving from economic cataclysm.

  10. Props for crediting MMT.

    As you say, this is not innovation in macroeconomics or politics. At the time of the Great Depression, New Deal and WWII, it was advised by Fed chair Marriner Eccles and FRBNY director and then chair Beardsley Ruml, for instance.

    As Paul Krugman has noted, what was known previously has been forgotten. MMT economists admit that most of their contribution has been weaving various existing thread together, for example, Wynne Godley's SFC macro modeling using sectoral balances, Abba Lerner's function finance, and Hyman Minsky's analysis of financial instability, as well as his proposal for an employer of last resort-job guarantee similar the the WPA and CCC of the New Deal, which was later the inspiration for the Peace Corps created by JFK.

    BTW, as you may have heard, MMT economist Stephanie Kelton has just been hired as chief economist for the minority of the US Senate budget committee, and she is taken a two year leave of absence from the University of Missouri at Kansas City. Hopefully, she can get the ball rolling on some of this in the US Congress.

    1. The Owl has Flown. Stephanie Kelton is on her way to Washington.

      So where is our Stephanie Kelton in the UK? Where is our academic centre for MMT; where is our equivalent of the University of Missouri Kansas City and the University of Newcastle, New South Wales? Is there no grant money for MMT in the UK?

      Just asking???

    2. We used to have Wynne Godley but Thatcher stopped the funding in the 1980s. Someone who used to work with him does a blog

      Wynne Godley is an author of the text book
      It says in the credits that funding and advice came from Warren Mosler who is a king-pin of MMT (even though the Godley stuff comes across as more utilitarian and less cultist than most MMT stuff).

    3. S. Explain "cultist". Can you see something that is stopping MMT being "populist". How do we make MMT go "viral", to use a modern idiom?

  11. Seven thousand years ago this was known. And thanks for the update. So that is it. Demand deficient stagnation is easy to prevent technically. The huge waste of resources that we see in the long and incomplete US recovery, the even slower UK recovery and the absence of recovery in the Eurozone are all unnecessary, because we know how to fix them

  12. Prof. Wren-Lewis:

    It seems you are recommending policies and an institutional setup of 50 to 60 years ago:

    Fine-tuning the economy by the government (aka as stop-and-go )with the help of a central bank doing the government's bidding.

    It didn't work out. Why should it work now?

    1. No. I'm simply pointing out that with the setup we currently have money financed fiscal expansion has been ruled out, which is costly at the ZLB when governments fixate about deficits. The solution, as others have observed, can go either way in terms of government delegation.

    2. Mainly Macro1 January 2015 at 05:32

      A rather circuitous way to reach that conclusion - benevolent dictators, non-independent central banks etc.

      If there are two mutually independent authorities to take care of economic matters - the government and the central bank - differences of opinion and conflicting decisions can occur. That is what nations that chose independent central banks signed up for - and that is an argument you like to use in other connections. So, accept it.

    3. It seems you are recommending policies and an institutional setup of 50 to 60 years ago: Fine-tuning the economy by the government (aka as stop-and-go )with the help of a central bank doing the government's bidding.
      It didn't work out. Why should it work now?

      Depends on what one means by "working out". If one means that quasiKeynesoid policies & institutional setups yielded the best period of broad-based prosperity in world history. It did in fact work out.

      If one means that this scared elite aristocrats-in-their-own-minds that this was a horrible "crisis of democracy" & that egalitarian prosperity was unnatural and undesirable to those natural masters, well then it didn't work out by the same token. They decided to end the egalitarian prosperity, and used the 1970s inflation, abetted by the amnesia and decay of academic economics, as an excuse to end the postwar golden age.

    4. Calgacus1 January 2015 at 13:51

      If those policies were so fine, why were they not continued? (Please no conspiracy theories.)

    5. Calgacus1 January 2015 at 13:51

      Those werde the good times in other countries, too. Some tried fine-tuning - France (the "Trente glorieuses"); others did not - Germany (the "Wirtschaftswunder" or economic miracle).

      That indicates that the policies were of little importance in a favourable situation. The real question is what the right policies were when that situation ended - the Seventies and after

    6. I guess those policies were abandoned because there are two key conflicting forces acting. There needs to be broad based prosperity in order to have enough demand for a thriving economy BUT an economy that provides an ideal repository for savings will entice capital inflows that will create favorable terms of trade. By the 1970s we had broad based prosperity but basically the UK was a poor choice to put your money. There was investment and growth in the developing world in the 1970s whilst the developed world started to flounder and was no longer able to buy all of the global commodities. The 1980s reversed all of that and all of the money flowed out of the developing world into the developed world and once again we could get everything.

    7. If those policies were so fine, why were they not continued? (Please no conspiracy theories.) The definition of policy success of the rulers and the ruled became very different. What a conspiracy theory! What a surprise!

      Those were the good times in other countries, too... That indicates that the policies were of little importance in a favourable situation. The real question is what the right policies were when that situation ended - the Seventies and after.

      The policies were the same, basically the whole world over. Above all to maintain (something like) full employment - more important than everything else put together. Something which no state that ever tried ever had much difficulty in doing. Differing situations (arguably favorable or not) were secondary.

      Paul Volcker famously declared in Business Week that the average American would have to accept a lower standard of living. This decision was successfully executed. In the "unfavorable situation" of the 70s stagflation driven by oil, the flation imposed an external constraint on real incomes, real wealth, real welfare, with the inflation being one way of distributing the burden. But the "stag" was completely unnecessary, a wound intentionally inflicted by one class on another, with the inflation as the excuse, and if anything it increased inflation in the long run.

      Bill Mitchell & Joan Muysken's Full Employment Abandoned details the worldwide abandoment of full employment and the subsequent damage. Mitchell's former student Victor Quirk has amassed and written about many other statements of clear intent like Volcker's during the 70s and earlier periods of assault on non-elite living standards.

  13. What a divergence between examining specific examples and throwing money at a problem!

    For example, the U.S. Military is being reduced. Each person 'reduced' is out of a job and forced into a search for an income stream to sustain life. At the same time, other government workers were given a pay raise. They could live better and easier.

    Some economist would say that this is an example of throwing money out to solve a problem. Give money to some so that they could buy more from the people just laid off.

    Other economist might say that government actions caused a problem. The stable situation would have been maintain the military and no government pay increases.

    In my mind, the simple monetary solution of passing out money to solve problems is equivalent to passing out candy to solve plugged plumbing. The better solution is to give candy to the plumber.

  14. Or, maybe there are simply too many people in the military, especially at the top...and maybe some government workers, especially those with advanced degrees and large spans of control, are simply underpaid vis-à-vis private sector equivalent positions. Maintaining the military with no government pay increases would exacerbate...not resolve...both problems. Since when did stability become the objective? Simon's thesis here is not complicated and is well supported by historical reality and sound economic theory.

  15. This comment has been removed by the author.

  16. In terms of political feasibility, it might be more palatable to give the central bank the additional authority of setting the size of the yearly budget. Once that's set the political institutions would decide how to allocate that money.There would be less loss of political power. The government still gets to decide where to spend the money. They only give up the power to decide the total budget for the year. What do you think?

    1. I do not think that is a good idea. A central bank does not usually have the expertise to think about long term debt sustainability, and is often deficit phobic. The problem only arises at the ZLB. I have a proposal with Jonathan Portes, which could easily be adapted to include money financing.

    2. I still don't understand why money financing is suggested as a solution to our current problems when treasury bill yields are next to nothing or less than nothing. Its not as though debt financing is currently providing any impediment to government spending is it? If the problem is that our governments don't like deficit spending then how is that helped by money financing? The deficit is just the same (for good or bad) irrespective of whether it is money financed or debt financed isn't it?

    3. For whatever reason, governments seem very concerned to reduce government debt, but are happy to see huge increases in money. I agree it is odd. What this post says is that - given this odd state of affairs - why not let the increase in money be used effectively?

    4. Perhaps governments are not as stupid as that. Perhaps they do want to reduce debt (perhaps for political reasons that conflict with the aims you and I want) and they largely consider money and the other government debt securities (which is what bank reserves are after all) in aggregate. Governments are relaxed about large scale QE exchanges of money for government debt perhaps because they take the same view as MMT types (or John Cochrane) that those exchanges are largely immaterial. You don't seem to be arguing against that view either and yet you're seemingly hoping to pull the wool over the eyes of the government by saying that money financed deficit spending (with a consequent increase in "net financial assets" as MMTers would put it) is somehow similar to QE rather than being just like regular bond financed deficit spending.
      It all seems even more of a charade when we've actually had enough QE such that it has largely been the stock of money that has increased rather than the public stock of treasury bonds (and yet as you note deficits are still seen as a problem by the government) and it is the interest paid on bank reserves that is the only thing keeping treasury bill yields positive.
      The UK treasury have switched over to issuing more bonds as ultra long duration haven't they? To that extent I guess the government has been trying to undo the (meager) effects that QE could have on the nature of the stock of "net financial assets" (lots of bank reserves and some ultra-long gilts being in aggregate a bit like say 10year gilts). I really think it is forlorn to hope that the government has some irrational blind spot where they fail to see money as debt.

    5. I doubt if governments think in these terms. More plausibly they think that they are in charge of having a responsible fiscal programme over the medium term, and that the central bank has been delegated the task of short term stabilisation. Which is fine, until you hit the ZLB. So if this mindset is an immovable constraint (which it appears to be in the Eurozone at least), the trick is to keep within this mindset, but give the central bank an effective means of getting round the ZLB.

    6. I'm really confused now. Your previous post was clearly about wriggling around the eurozone mess but this post seemed to be proposing money financed deficit spending by the government as a general solution applicable for the UK and USA too. Am I right in thinking that you are saying that the central bank should in effect size power and say that since the central bank has the mandate to establish full employment and 2% inflation, then the central bank should conduct fiscal policy in the form of paying out a citizens' dividend because that is the only way to achieve that mandate?
      I'm a big fan of having a citizens' dividend but I'm an even bigger fan of democracy. I wish the central bank would just say to both the government and the electorate, don't expect the central bank to get us out of this mess because we don't have the means, instead you have to elect a government that will pay a citizens' dividend because that is your only hope.

    7. I'm not sure I'm proposing anything very particular. What I'm trying to point out that we currently have a delegation regime that fails at the ZLB unless governments do the right thing. We could think of various ways of avoiding this. For example the central bank could specify the size of any (money financed) fiscal stimulus, and leave it up to the government how to enact it. I really wanted to start a discussion that at least asked whether the current delegation regime could be improved, given the disaster of the last few years.

  17. I agree. I suggested the central bank to keep the idea simple. Better would be a separate and independent agency with competent economists.

  18. And just now our economy is running below its capacity .. isn't it great that there is this enormous challenge of climate change and and energy transition that needs to be taken up? No need to dig holes for bottles with money and close them up again. We could get active and transition towards a sustainable economy. That is a political objective of course. But it is held back because people are saying 'there is no money', and discuss that spending more on climate mitigation would not stimulate the economy, but reduce growth. In contradiction to the idea that more spending on useful things would be a stimulus for doing more useful things. The beancounters rule, but it seems they cannot count.

  19. How exactly will the printing of money or issuing of debt increase the welfare of a people?

    Is it not the purchasing power and the distribution of income and wealth that are the deciding factors in all of this? The acceleration of credit growth in excess of economic growth started exactly with Reaganomics and at the same time when the gap between the different income groups started to widen. Is this simply coincidence? Not in my play book.

    Governments have the inherent quality to mess things up as they are not able to think longterm but simply until the next election cycle, and the politicians and bureaucrats tend to increase their power over their population mostly in favor of vested interests. It is hardly a smart idea to increase central planning functions by the government further but we rather should cut back the power of these corrupted bureaucrats in this crony capitalistic system.

  20. Ok geniuses here's the deal I will only explain this once and if you don't understand, may I suggest, you folks get out of the business. Interest is loss, a way to understand this, is you can create principle, but interest is never figured into the equation, but for and as a feature; it’s loss, by someone along the trail. The Federal Reserve System is, merely, a high stakes gambling casino, at the people’s expense, in more ways than one.

    Money spent on suppliers, labors receipt of payment and so on, do not, equate to more than the actual principle, in circulation at the time; in, any way you figure it. So any gain is another man’s loss, no matter, how you spell it. A cycle, of, booms and busts facilitates the illusion, of a healthy system, thus providing the money to pay interest. A system of ups and downs that serves to give the impression the market is for everyone, and, everyone has the same chances.

    One action puts money into circulation, booms, one collects it back along with assets, these being busts, therein serving as the conduit to pay savers, then the other winners of the game, on, Wall Street, and then the, croupiers, of this Casino, the Banks.

    Which would be, a reason, that savers are being discouraged, from, being such with negative interest, because, savers aren’t part of the game, but as a casualty, a savings account is a silent accusation, of, the systems immorality. One can accrue interest on animals and seed but one cannot attain interest on sterile inorganic money.

    It’s a race to the bottom with the Federal Reserve, who only accepts gold and property in specie, and those who play this rather sick game of resources, there to accept the proceeds. The reason no one can model it, and have any accuracy for any time, is all the models are built on this, misguided perception, you have, that, the system you work with, is neutral.

    When, in fact, it is a predatory rents extraction, and assets, property, and wealth extraction system and is immoral.

    You fail to demand or postulate, that, a moral component, should be a part, of, any economic model and therefore, a, lack of said, will never show up on your radar, as, the reason for the current shape of things and apparent bad decisions on the Banks part. Therefore “Gresham’s Law” is unfettered in its effects.

    The sooner you figure this out and design a more, fair, system the better off you will be. Doesn’t really require a fancy theory or a lot of work to understand. If you have, no demand, for moral behavior, as, a component of your models, then moral behavior will not be a result. Thus a healthy predictable economy is impossible to predict us it not?

    1. Can you try to paraphrase that in clearer English?

  21. "just tell me how you get out of a liquidity trap in a world with inflation targets after reading this post (and maybe this)."
    In response, I have a theory: The US dominated global economics from 1945 until about 1970 because we were the last man standing after WW2. We made fortunes rebuilding the world and selling US products because nobody else could. I remember in the 60s seeing newsreels of still bombed out buildings in England and Germany as reconstruction was in its final efforts. Lo and behold and the world caught up. The previous centuries were dominated by European colonialism and Western mercantilism. Then all those colonies became independent and started competing with the west on a level playing field with their low wage industries. This changed the balance of trade and eventually American wage levels. Unfortunately, I don't see anyway out of this as ultimately, we will just stagnate for a while until the lesser developed world develops a similar level of wealth and commensurate wage levels. I don't see this as a catastrophe. The US with 5% of the worlds population at one time consumed 20% of the worlds resources. This is changing. It is ironic that now China is loosing factories to even cheaper countries in south east Asia. I foresee a period of about 20 years where the rest of the world catches up and then a new normal will take place with renewed prosperity. In the meantime, we may just have to tighten our belts a bit and make due with the relative wealth that we still enjoy. Finally, I don't think fiscal or monetary policy will fix this. It will just create more debt, an eventual drop in the strength of the dollar, and higher prices with commensurate drop in real consumption.

  22. The post talks about the liquidity trap at the ZLB in a world of inflation targeting. Wouldn't it be easiest just to drop the inflation target and replace it with NGDPLT? Or, more simply, income growth (level) targeting? Set this at 5% with a flex of 1-2% either way, so the inflationistas don't get worried and the deflation trap we are in now also gets avoided.

  23. Dear Prof. Wren-Lewis,

    Thank you for your clear and concise exposition of your macroeconomic beliefs.

    Unfortunately, they do not appear to be supported by history. Up till now, growth in free economy systems - the relatively best systems for growth and widespread prosperity - has always been discontinuous. It has always been interrupted by unforeseen downturns: after some steps foreward, one or more steps backward occurred, occasioning economic loss - but the result was over all positive.

    Now, you believe that history can be changed and that economies can be steered to avoid those losses. That is what many economists believed during the "Great Moderation", which they thought would never end.

    Why am I sceptical about your optimism?

    You seem to consider demand in an economy to be homogeneous. You underestimate frictions and time lags in the creation of new demand to compensate the fall in previous demand.
    In an economic downturn, people will have less money to spend time with their families at the beach. The demand for frisbees will fall; frisbee workers (mostly women?) will lose some of their jobs.
    The governmet that tries to compensate loss of demand will not buy frisbees. It will try to build roads, bridges, internet connections etc. But that takes planning, and that takes time (esp. if the local population objects). It will not help frisbee workers in the short run.
    The only thing that works in the short run are raising transfer payments. Even tax cuts usually require time-consuming adaptations in the tax bureaucracy. And higher transfer payments will hardly start a boom in capital goods.

    So, it is not easy to raise demand through government expenditure or to raise private expenditure through government measures. And by the time they work, the economic situation may have changed.

    So it is not true that demand deficiency is "easy to solve technically." There is a problem of stickiness there, too.

    You admit that raising demand through government measures may lead to a higher stock of money that may prove to be "too great later on" (the usual word for that is "inflation").You believe it can be reduced by various means so there will be no "subsequent above target inflation." Unfortunately, those means are invariably unpopular (raising taxes or interest rates) and can produce their own economic losses, see Volcker.
    Of course, benevolent dictators need not spare the rod, but politicians wanting to be democratically re-elected know that the best way is spoiling the voters. As Krugman says in his textbook: "Disinflation is hard."

    Can you resolve those doubts?

  24. Why don't Krugman or Summers take up money financed deficits? It's the obvious solution to secular stagnation, and key to a happier world. It's just "Functional Finance" advocated by Abba Lerner in the early 1940s.


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