Tuesday, November 16, 2010

Is US Right to Print Money?

The US has experienced much criticism for the decision to pursue QE2 (a policy of increasing money supply to buy long dated securities) and allow the dollar to depreciate in value. For example, Joseph Stiglitz, former nobel economics prize winner, has criticised the policy.

Criticisms of Decision To Pursue Q.E.
  • Interest rates are already low and US banks have substantial liquidity. It is not clear how attempts to reduce long term interest rates and increase liquidity even more will help boost growth , given the unwillingness of banks and firms to lend and invest.
  • Lowering long term interest rates creates danger of leading to a future mis-allocation of resources. If interest rates are artificially low it may lead to an inefficient use of resources and poor investment decisions in the private sector. For example, in 2001, the US cut interest rates very low after downturn and (combined with weak regulation) this lead to boom and bust in asset markets which led to last credit crisis.
  • Stiglitz argues that fiscal policy would be more effective in boasting growth. For example extending benefits to the unemployed would be spent (very high mpc) Given liquidity trap, expansionary fiscal policy in current climate would not lead to crowding out, but would help boast growth. (Stiglitz at FT)
Other Criticisms
  • Other criticisms from the right focus on the inflationary potential of QE and argue this will lead to future inflation and decline in living standards.
  • China and other exporters argue it is unfair for US to reduce value of dollar trying to gain from a competitive devaluation at their expense.
Defence of Q.E
  • Realistically, governments are not going to be pursuing expansionary fiscal policy, in current climate, because of concerns over credit ratings. Therefore, expansionary monetary policy is one of few options left to avoid deflation and prolonged unemployment.
  • The US has a right to pursue independent monetary policy.
  • The Fed have a duty to avoid deflation and prevent inflation falling. It would be irresponsible to do anything else.
  • Prospect of hyper inflation is slim.
  • The current situation is different to 2001. 2001 was a mild downturn, it wasn't a liquidity trap with aftermath of asset bubble burst. The unusual depth of current downturn means we need to turn to unorthodox policies.
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2 comments:

Basudeb Sen said...

Worth of Criticisms of Decision To Pursue Q.E.need to be judged. First, assume that attempts to reduce long term interest rates and increase liquidity even more will not help boost growth , given the unwillingness of banks and firms to lend and invest. Then, what is the problem? IF QE2 cannot reduce interest further or cannot force higher growth of credit, there is no worry with QE2 producing any good or bad effect. Second, if the first argument is valid, the criticism that
lowering long term interest rates would create danger of leading to a future mis-allocation of resources cannot hold good because interest rates cannot get lower as per crticism 1. Moreover, given the huge under-utilized capacity in the US, there is little chance of inflation rising fast in the short-term. When space capacity gets utilized the QH (Quantitative Hardening) policy can be implemented to counteract upward pressure on prices.
Stiglitz's argument is correct that fiscal policy would be more effective in boasting growth. But the example of extending benefits to the unemployed(very high mpc)does not help because high mpc may mean only importing more of Chinese goods that would not increase domestic economic growth in the US. It would be better for the US Fiscal policy to increase spending on government purchases of domestic goods where domestic capacity is surplus and then sell/ donate these goods to poor countries who need them as an incentive to these countries to buy high technology goods from the US: ( x number of US cars free for buying a Boeing jet or an US super-computer or a nuclear plant. If the external value of the US dollar falls due to QE2, then the rate of incentive for exports would be lower. With lower value of dollar, even some US technolologists and technicians will become cheaper for other countries to import.
The criticisms from the rightthat QE will lead to future inflation and decline in living standards is besides the point. Even without QE living standards would be falling until the economy recovery picks up and decent growth resumes.
It is comical of Chinese exporters to term QE in US as an unfair competitive devaluation at their expense when for decades together China has been unfairly pegging its currency's exchange rate pegged to the dollar notwithstanding continuous huge trade surplus being created by China at the expense of the Chinese labor. If China allowed free flat of the Yuan, the whole international economy and the Chinese labour would have benefited.
Defence of Q.E

Realistically, governments are not going to be pursuing expansionary fiscal policy, in current climate, because of concerns over credit ratings. Therefore, expansionary monetary policy is one of few options left to avoid deflation and prolonged unemployment.

The US has a right to pursue independent monetary policy.
The Fed have a duty to avoid deflation and prevent inflation falling. It would be irresponsible to do anything else.
Prospect of hyper inflation is slim.
The current situation is different to 2001. 2001 was a mild downturn, it wasn't a liquidity trap with aftermath of asset bubble burst. The unusual depth of current downturn means we need to turn to unorthodox policies.

Musgrave said...

Good points by Basudeb Sen above. Now for my points.

To describe QE as “money printing” is a very questionable use of the phrase. At least it’s very questionable where it is government bonds (i.e. Gilts) that are “eased”. And in the case of the U.K. about 99% of bonds eased have been Gilts.

Gilts and monetary base both appear on the liability side of the Bank of England’s balance sheet. In other words Q.E. is nothing more than swapping one bit of valuable government produced paper for another, to put it in illustrative form.

As for short dated Gilts, they are little different from cash. Where a short dated Gilt is eased, this is little different to swapping a £20 note for two £10 notes.

REAL MONEY PRINTING to my mind consists of combining monetary with fisacal policy, i.e. having the government / central bank machine just create new money and spend it.