Saturday, August 22, 2009

Quantitative easing and fiscal stimulus are both fool’s games

Via:  Daily Finance

It is still the pathetic wet dream of neo-Keynesians and neo-conservatives alike that inflation is going to accomplish the debt jubilee that they think is going to “reflate” our deflationary economies.

PIMCO: Fed needs to 'be irresponsible' if deflation appears
Joseph LazzaroJoseph

To borrow a phrases from the late, great Jimi Hendrix, wrap your mind around this one: would you root for an "irresponsible" Fed?

PIMCO's Managing Director Paul McCulley is doing exactly that. McCulley, in a PIMCO commentary, said that, if the U.S. economic recovery does not begin as expected in Q3/Q4, the Federal Reserve should push inflation above its long-term target to encourage U.S. consumers to spend money.

"The way to make monetary policy effective is for the central bank to promise to be irresponsible," McCulley wrote, citing a 1998 paper written by Nobel Prize-winning Princeton University economist and New York Times (NYT) columnist Paul Krugman.

My primary objection to this line of thinking is that it ignores the primary cause of deflationary depressions, too much debt on a highly unequal income distribution.  Simply put, some people have too much money while everyone else has very little money and too much debt—not enough money to spend to keep the circular flow of income and product going, let alone service their debt.  This is where we are today.  America is a rich country compared to most others and compared to ourselves a generation ago—there’s plenty to go around, but since Reagan the game has been tilted toward capital and rich folks.

But what qualifies Krugman’s remarks as obtuse, in the sense of biting off his own nose to spite his face (and I apologize for getting wonky a bit here, it’s something I’ve sworn off of since leaving academic economics, but every once in a while fall back into) is that the Fed can’t at once be credible in its stated policies of monetary control and at the same time promise to be irresponsible by igniting inflation.  That is incredible, literally.

It’s the debt, stupid, and the income distribution, the fact that the game is rigged by social conventions accepted by—or imposed upon—folks up to now.  Bad debts don’t get repaid by reflation, the cash flow coverage on the loans was never right and won’t be made right by inflation.  And not to get wonkish again, but you introduce all kinds of inefficiencies into the economy when you cause uncertainty about relative prices—because as Hayek pointed out, he who raises his price first wins—and given the state of our social contract, that’s not likely to be the people who need help the most.

What to do?  Follow William Black’s example in the S&L crisis and bust bad bankers, close their banks, write off their crap, break up Goldman Sachs (bring back Glass Steagall—there’s no way Goldman should be getting free money from the Fed), and provide a livable workfare-style dole and health benefits to the unemployed, who are going to be with us for a while. 

Quantitative easing and fiscal stimulus are both fool’s games, blind to the true nature of the problem, the broken distribution.  Fiscal stimulus will be distributed as unequally as the banking bailouts were.  The social contract needs to be renegotiated.

Reference: Income inequality, debt, crisis and depressions


  1. The correct course of action won't be taken because it would jeopardize the re-election chances of the powers-that-be. Can't risk upsetting the monied classes lest the cash stop flowing into the campaign contribution and retirement funds of our elected officials.

    I'm an engineer, not an economist, but it seems to me that the Anglo-American economy is dynamically unstable and that adding more debt increases the instability. The economy can stabilize for a time, but each new "crisis" is bigger than the last. Like the Tacoma Narrows bridge, something has to give eventually.

    As engineers study the Tacoma Narrows bridge episode to learn the pitfalls of engineering, I predict sometime in the future economists-in-training will study the Bernancke-Paulson-Geithner-Summers response to the "Great Recession" to learn what not to do in a asset-bubble implosion and deflation.

    Thanks for the blog.

  2. To make it even more interesting most developed nations have mimicked the Anglo-American fractional reserve central banking model that may amplify this crisis. As all of these folks seem to crave inflation, and having a hot war is historically associated with getting an inflation going, it would seem the likelihood of war (or escalation of current wars) has increased.