Thoughts on the Limits of Monetary Policy in a Liquidity Trap... One question advocates of expansionary fiscal policy in situations like the global economy's current configuration must face is Mankiw and Weinzerl's [1] question: why not just use monetary policy instead?
The principal argument for monetary policy is that, by modifying asset supplies and thus asset prices, it induces households and businesses to boost their spending on things that they almost bought anyway. Thus--for marginal policy shifts, starting out at a first-best optimum, and if the relative distribution of wealth corresponds to social welfare (or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)--monetary policy will not push you far away from the free-market optimum.
Fiscal policy, by contrast, works through expanded government purchases ΔG. These must be financed by distortionary taxes to amortize the debt in the future. . [6] John H. Monetary policy: The zero lower bound in our minds. Philip Pilkington: Is QE/ZIRP Killing Demand? By Philip Pilkington, a journalist and writer living in Dublin, Ireland Warren Mosler recently ran a very succinct account of why the Fed/Bank of England’s easy monetary policies – that is, the combination of Quantitative Easing and their Zero Interest Rate Programs – might actually be killing demand in the economy.
Mosler’s argument runs something like this: when interest rates hit the floor they suck interest income payments that might flow to rentiers and savers. And no, we’re not just talking about Johnny Moneybags refusing to buy his daughter a new Prada handbag (which, say what you will, creates job opportunities). We’re also talking about regular savers and, as the Fed recently noted, pension funds seeing their income fall – not to mention certain industries, like insurance, finding their profits lowered (and hence their premiums raised?). Mosler sums it up well: Lowering rates in general in the first instance merely shifts interest income from ‘savers’ to borrowers. Why ZIRP doesn’t work. Bill Gross has a wonky column in the FT, saying that setting interest rates at zero doesn’t boost economic growth: With policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.
Certainly the record will show that countries with persistently low interest rates tend to have sluggish growth, and although the obvious causality there runs the other way — central banks cut rates in response to slow growth — it’s never been clearer than it is now that such policies don’t always work. Gross’s point is that zero rates, far from encouraging people to borrow more, actually encourage deleveraging instead, at both the short and the long end of the curve. Why wouldn’t people want to borrow at ultra-low interest rates? Fed May Signal Low Rates Into 2014. AC2011 Session 1.2 Come Undone: Kyle Bass redux. Stephen Roach: America is a Zombie Nation just like Japan. Cross-posted from Credit Writedowns Stephen Roach has written an Op-Ed in today’s Financial Times that is worth reading.
He outlines his version of Richard Koo’s Balance Sheet Recession theorem, opining that “the global economy is being hobbled by a new generation of zombies – the economic walking dead.” His main points are: American consumers are retrenching. In the 3 1/4 years since 2008 began, real consumption growth has averaged 0.5% on an annualised basis, the lowest since World War II. Roach’s conclusion: Washington policymakers are doing everything they can to forestall rational economic adjustments. That “Washington policymakers are doing everything they can to forestall rational economic adjustments” is certainly the conclusion I have drawn both regarding Japan and regarding the US.
First, on Japan: Second, on the US: If the US wants job growth, it will need to reduce private sector debt levels – and that takes time. Third, in general: The US Follows Japan Into A Balance Sheet Recession: What Do Investors Know and Why Is It That Policymakers Appear Clueless? BoomBustBlogger and Director of Research at Paisley Financial, Mario Ricchio, writes on the abject futility of QE during a balance sheet recession.
That is where I, and he, believe the US and Japan are right now. See my video take on this from a real estate perspective here. You can download Mr. Ricchio's report via this link, but in the mean time I would like to highlight some of the not so common sense remarks that I came across in such. When the U.S housing bubble burst, the effects reached far beyond the decline in home prices and in construction-related employment. A debt-financed asset bubble precedes a balance sheet recession. Richard Koo - Europe in a Balance Sheet Recession - Time for QE. Liquidity traps and the credit crunch.