Inflationists in Wolves' Clothing
For some time now I have been warning my Austrian readers of the inflationist threat coming, not from the Keynesian camp, but from otherwise free-market Chicago School economists. Some of the leaders in this "quasi-monetarist" or "market-monetarist" school are Scott Sumner, Bill Woolsey, David Beckworth, and Lars Christensen. Their basic position is that we are in a severe economic slump because Ben Bernanke has been too tight with monetary policy the past three years.
Even though their conclusion strikes me as absurd, these quasi monetarists are serious thinkers and it would be a big task to comprehensively critique their position. (I've made modest efforts here and here when they defended QE2.) Yet despite their sophisticated calls for the Fed to "target NGDP growth," shape expectations, and so forth, in practice their message is being distilled by the secondhanders into calls for unadulterated handouts of paper money. As we will see, I don't have to engage in caricature; pundits like Matt Yglesias and Martin Wolf are openly calling for helicopter drops of money as a solution to our economic woes.
This is a very disturbing development. Just as the interventions (which crippled recovery) of the Hoover administration in the early 1930s led to a massive increase in government under the New Deal and the abandonment of the gold standard, so too have the "stimulus" packages and other failed programs of the Bush and Obama administrations gotten us to the point where raw money printing is being seriously discussed as a policy option.
Yglesias and Wolf on the Printing Press
My view is that the best demand of all [would be] "free money for the rest of us." There are a lot of different specific ways this can be implemented, but the basic shape of things is that the Powers That Be are great believers in the importance of the credit channel to economic recovery and thus have been willing to provide all manner of free money to players in the banking system. Debt cancellation is a form of free money for the indebted. But why give free money only to banks? And why give free money only to the indebted? Why not free money for everyone? "Everyone," of course, includes the indebted. But it also includes ordinary people who didn't happen to avail themselves of the credit binge. It's an idea so good that it sounds almost silly. "Everyone knows" that you can't just hand out free money to everybody. Except actually you can. Most of the time it wouldn't be advisable to do this. In the long run money is neutral, and making more money can't make you more prosperous. But in the short term, free money for everyone impacts prices. Most of the time it would do so in a dislocating bad way, but under today's circumstances, it would do so in a useful way. I don't know what the best way to turn this into a slogan is, but the point is that if the different institutions that together constitute "the government" worked together, they could put more dollars into our hands. Creditors won't like it because doing this will devalue their existing debt claims, but so what.
To the untrained eye it might seem as if Yglesias is utterly bereft of economics training, but actually he is simply giving a pop version of the worldview of the quasi monetarists. Yglesias's recommendation to have protestors demand "free money for everyone" is actually logically consistent with the much more nuanced views touted by the academic economists I've linked above.
When I saw Yglesias's post, I was disheartened, but I took comfort in the fact that, after all, he was just a young guy firing off snappy posts. The "serious" members of the intelligentsia — guys who were over 50, flew in private jets, and have never played Grand Theft Auto — surely wouldn't fall for such raw inflationism, right? Except that distinguished FT columnist Martin Wolf recently wrote,
It is the policy that dare not speak its name: the printing press. The time has come to employ this nuclear option on a grand scale.…
What is to be done? The first task is to abandon what Adam Posen, an outside member of the monetary policy committee, calls "policy defeatism."…
It is vital, then, to sustain demand. With fiscal policy set on kamikaze tightening and conventional monetary policy almost exhausted, that leaves "quantitative easing".…
Personally, I would favour the "helicopter money", recommended by that radical economist, Milton Friedman. This would be a quasi-fiscal operation. Central bank money could pass via the government to the public at large. Alternatively, the government could fund itself from the central bank, directly. Better still, the government could increase its deficits, perhaps by slashing taxes, and taking needed funds from the central bank. Under any of these alternatives, the central bank would be behaving like any other bank, creating money in the act of lending.
In current circumstances, a policy of direct financing of government by the central bank should recommend itself to monetarists and Keynesians. The former have to be worried by the fact that UK broad money (M4) shrank by 1.1 per cent in the year to July 2011. The latter would have to be pleased that governments could run still bigger deficits without increasing their debt to the public.
This is where the discussion of monetary policy has landed: we are now openly discussing having the central bank print up new money to pay the government's bills, and this is supposed to be great because it won't cost the taxpayers anything.
This situation is ironic because for the last three years, analysts have said things like "Investors right now are content with low yields on long-term bonds, because they trust the Fed to adhere to its inflation target. But if they ever sensed that the Fed was beginning to monetize the government's debt — as happened in Zimbabwe — then all bets are off and we'll see a sharp increase in inflation expectations and bond yields."
This struck some of us as ludicrous because by definition QE1 and QE2 were operations in which the Fed created hundreds of billions out of thin air in order to buy Treasury debt.
At least before, however, the analysts could be forgiven for not seeing the obvious. After all, Fed officials did a great job obfuscating what they were doing. They made it sound as if the government's Treasury were just sitting there, minding its own business, and the Fed said, "Hey, we need to buy hundreds of billions of bonds from some organization in order to achieve our interest-rate objectives. Any ideas?"
Now that Martin Wolf (and a growing chorus of other inflationists) is openly calling for central banks to monetize deficits, I wonder if we will at least classify the operation as monetizing deficits. That would be progress.
Austrian and Public Choice versus Chicago
Among other lessons, this latest development illustrates the importance of having different schools of thought, even among those who are generally free market. Wolf is being entirely fair when citing Milton Friedman, for it was Friedman (and coauthor Anna Schwartz) who famously blamed the Great Depression on tight monetary policy. We can't know what Friedman himself would say were he alive today, but people like Sumner have made a convincing case that Friedman would call for more inflation.
On these pages we have argued many times that artificially low interest rates and monetary inflation misallocate resources and in fact set the economy up for a further crash; I won't rehash the argument here. Let me simply reiterate that it's an odd thing to blame our current woes on "tight" monetary policy, when the monetary base and the M1 monetary aggregate look like this:
I've had such arguments with the quasi monetarists before, and we always reach a standoff: they focus on things such as "sticky prices," money demand, and "expected growth in total income," whereas I focus on the coordinating role of market prices, and the capital structure.
In light of the calls for "free money" (for everyone or for governments, respectively) by Yglesias and Wolf, perhaps the public-choice school of economics will have something to say here. Once we let the inflation genie out of the bottle — even if it were the "right thing to do" in these unusual times — can't free-market economists see that it will never go back?[product:0]
For example, if the Fed really did guarantee a basic income to every American — as Yglesias discussed in an earlier blog post — wouldn't that policy be as hard to end as Social Security? If the Fed began making loans directly to small- and medium-sized enterprises (as Wolf discusses in his piece), wouldn't capital allocation become irreversibly politicized?
The world has been in a strange environment in the last three years, in which massive expansions in central-bank balance sheets haven't led to $10 gasoline and $5 loaves of bread. Regardless of which school of thought can best explain these events, we are all going to rue the fact that the grand lesson flowing out of this episode is that money printing can bring prosperity. Now that this idea has firmly taken root, it will take a large collapse in consumer purchasing power to remind everybody why "inflation" used to be a dirty word.