Quantitative easing: why it doesn’t work

Laying the foundations for recovery

In the second year of my economics degree we were mixed in with some first years for some lectures. In the first week one of the freshers asked “Why don’t we just print more money, give it to people, and make them richer?”

We second years laughed, but that economic ingénue might be having the last laugh. As the Bank of England prepares to print another £75 billion of new money, she seems to have a seat on the Monetary Policy Committee.

Quantitative easing is the purchase by the Bank of England of financial assets so that the money spent on these will find its way back out into the wider economy.

But here’s the trick; the money the Bank spends on these assets is created out of thin air. The Bank, which controls the issue of British currency, simply creates as many new pounds and pence as it needs to buy however many of these assets it wants.

Whether this is inflationary depends on your view of the gradient of the short run aggregate supply curve.

For neo classical economists the curve is vertical, output is fixed, in other words, by real factors like the number of factories and workers. Any increase in the money supply simply causes higher prices. These economists believe money is neutral.

Keynesians disagree. For them, with idle resources in an economy, furloughed factories and unemployed workers, the aggregate supply curve is flat. It is possible, by increasing the money supply, to stimulate new output and employment because the spare capacity allows the amount of goods and services to expand with the money supply. Money is not neutral.

These are limiting examples. In practice most economists believe the aggregate supply curve is sloped, they disagree over the gradient.

Another area where neo classical and Keynesian schools agree is the transmission of this through the economy. Or, more accurately, they ignore it.

Their models are snapshots of a moment. They exclude the fourth dimension, time, and thus miss the transmission process.

They share the ridiculous notion of ‘helicopter money’ whereby newly created money, such as that used in QE programs, magically appears in people’s portfolios as though falling from a helicopter. This money is assumed to be scooped off the ground by each economic agent in proportion to their existing stock of wealth.

Austrian school economists don’t take this bogus notion seriously because they acknowledge that economic phenomenon exist in time. It follows that in the Austrian view monetary expansions are not neutral. They benefit some more than others.

The charts below from the work of economist Roger Garrison illustrate this.

Figure 1                                                             Figure 2

Garrison writes

“The vertical axis represents the nominal magnitude of the original stock of money (Mo), i.e., the stock in existence prior to the monetary expansion. The horizontal axis represents the nominal magnitude of the expanded stock of money (Me), i.e., the stock in existence after the expansion has occurred. The 45° line, representing the equality Mo = Me, serves as a reference. A neutral expansion can be shown, then, by rotating a line clockwise from the reference line” (in Figure 1)

But monetary expansions don’t occur like this. Helicopters don’t dispense the new money, banks do.

Money newly created by the fiduciary authority goes to them first. From them it goes to whoever they lend it on to. As Garrison says

“In (Figure 2) it is assumed…that all of the newly created money takes the form of credit extended to capitalists. Initially, then, the laborers are completely unaffected by the monetary expansion. This is represented in (Figure 2) by M’L, which is coincident with the 45° reference line. Capitalists, on the other hand, experience an initially amplified monetary expansion as indicated by M’c. But as the capitalists purchase additional quantities of labor services, the new money filters through the economy such that eventually the expansion experienced by the laborers is approximately the same as the expansion experienced by the capitalists. This is indicated by the expansion line Mi”c = M”L. The arrows indicate the dynamics of the expansion as it appears to the capitalists and to the laborers”

The capitalists in Garrison’s model, those first to receive the new money created in monetary expansions, get increased purchasing power. But by the time the money has filtered down to those furthest from the monetary expansion the effects have been dissipated by the rising prices created by the issue. They just get higher prices.

Garrison’s model shares the non neutrality of money of the Keynesian model and the assumption of fixed output of the neo classical model. What it adds is the effects of the expansion in time and in doing so it shows how iniquitous these monetary expansions are.

Summarising the work of Ludwig von Mises, Murray Rothbard wrote that monetary expansions like QE confer

“no social benefit whatever. In fact, the reason why the government and its controlled banking system tend to keep inflating the money supply, is precisely because the increase is not granted to everyone equally. Instead, the nodal point of initial increase is the government itself and its central bank; other early receivers of the new money are favoured new borrowers from the banks, contractors to the government, and government bureaucrats themselves. These early receivers of the new money, Mises pointed out, benefit at the expense of those down the line of the chain, or ripple effect, who get the new money last, or of people on fixed incomes who never receive the new influx of money. In a profound sense, then, monetary inflation is a hidden form of taxation or redistribution of wealth, to the government and its favoured groups, and from the rest of the population…”

 People will ring alarm bells and tell you QE is necessary. Many of them will be Garrison’s capitalists. But one thing they cannot tell you is that QE is fair.

This article originally appeared at The Commentator


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