Recently, I posted about the current fall in M4 lending in the UK. The concern is that fears over possible future inflation are preventing decisive action to promote economic recovery. But, these fears are misplaced. The fall in M4 lending in the UK is a sign of a fundamental weakness in demand. Given this weakness, policy should be aimed at increasing lending (this may require more than simple Q.E.). We should worry about inflation only when the economy is showing signs of real growth and capacity constraints.
Europe would also benefit from losing it’s religious faith in low inflation.
Today I spotted this post from Economists View, which posts some interesting graphs from the Great Depression.
Grey areas are recessions.
Clearly in the great depression, there was a collapse in bank loans due to the financial crisis. The economic recovery post 1933, was a period of rising loans.
There was a very sharp fall in the price level during the great depression. The recovery saw inflation, but that is what the economy needed. Better to have moderate inflation and economic recovery rather than continued depression.
The tragedy of the 1930s, was the premature tightening of monetary and fiscal policy in 1937, which caused a second recession.
To Summarise
- Quantitative easing may cause some inflation, but in a liquidity trap it will not cause hyperinflation
- It depends on the type of quantitative easing. Gilt purchases by the Central Bank may have little impact on bank lending.
- In a prolonged recession, the aim of monetary / fiscal policy may require higher inflation (or if people prefer – call it targeting higher nominal GDP)
- Monetary policy can be reversed. In an inflationary boom, you don’t refuse to raise interest rates on the basis, you won’t be able to solve unemployment at a later stage. You deal with inflation; then when the economy turns, you can cut rates. Similarly, if depression is the problem, monetary policy needs to be eased. You can worry about inflation, when inflation is actually a problem.
Related
“Monetary policy can be reversed”…Yes, but can its effects be reversed quickly? It is said monetary policy acts with “long and variable” lags.
QE affects bank reserves, not the money stock (supply). Unless banks are willing to lend to customers wishing to borrow, QE will not have a direct effect on demand (borrowing/lending). It may lower interest rates and encourage banks to purchase interest bearing assets, which may then increase the money stock.
Given the above and the BoE’s role as LOLR and an interest rate target we should not assume a direct link between reserves and money, as in the “money multiplier/multiple re-lending model”.
“‘In the UK money is endogenous’ by Mervyn King and ‘the money multiplier taught in macroeconomics courses amounts to misinstruction’ by charles goodhart.” (Quoted from Andrew Judd).
RS