Ritchie really is going with this debt thing, isn\’t he?

Do long as the banks do not lend this situation will persist. Bank lending has been the way we’ve made the money that the country needs to keep the economy going. As long as banks don’t lend, and that looks likely to be for some time to come since without an increase in one of consumer demand, business investment or net exports their lending is bound to fall, then it will fall to government to both fill the gap in the economy that they create by their inaction and at the same time create the money that’s needed to keep the economy going. So, I can pretty confidently predict that if, as the IFS suggest, the government deficit will be £120 billion next year, £99 billion the year after that and £79 billion in 2014-15 then you can be pretty sure that quantitative easing in those years will be £85 billion, £65 billion and £45 billion respectively leaving net borrowing at around £35 billion a year. Total government debt despite the deficit will, therefore, be no more than about £750 billion or so in 2015 which will be, give or take, about 50% of GDP, a figure that will be vastly lower than elsewhere in the Eurozone in particular. And we won’t have inflation as a result because, as a consequence of the actions of this government which have pushed almost 3 million people now o9nto unemployment, with that figure bound to rise over these years, wage inflation pressure will be virtually non-existent whilst the collapse of demand in the Eurozone will tkae the pressure off other prices too.

He really doesn\’t seem to realise that none of this is new. Yes, this is Wikipedia but it outlines the point nicely.

When government deficits are financed through this method of debt monetization the outcome is an increase in the monetary base, the money supply. If a budget deficit persists for a substantial period of time, the monetary base will also increase, shifting the aggregate-demand curve to the right leading to a rise in the price level.[3] When governments intentionally do this, they devalue existing stockpiles of fixed income cash flows of anyone who is holding assets based in that currency. This does not reduce the value of floating or hard assets, and has an uncertain (and potentially beneficial) impact on some equities. It benefits debtors at the expense of creditors and will result in an increase in the nominal price of real estate. This wealth transfer is clearly not a Pareto improvement but can act as a stimulus to economic growth and employment in an economy overburdened by private debt[citation needed]. It is in essence a \”tax\” and a simultaneous redistribution to debtors as the overall value of creditors\’ fixed income assets drop (and as the debt burden to debtors correspondingly decreases). If the beneficiaries of this transfer are more likely to spend their gains (due to lower income and asset levels) this can stimulate demand and increase liquidity. It also decreases the value of the currency – potentially stimulating exports and decreasing imports – improving the balance of trade. Foreign owners of local currency and debt also lose money, Fixed income creditors experience decreased wealth due to a loss in spending power. This is known as \”inflation tax\” (or \”inflationary debt relief\”). Conversely, tight monetary policy which favors creditors over debtors even at the expense of reduced economic growth can also be considered a wealth transfer to holders of fixed assets from people with debt or with mostly human capital to trade (a \”deflation tax\”).

A deficit can be the source of sustained inflation only if it is persistent rather than temporary, and if the government finances it by creating money (through monetizing the debt), rather than leaving bonds in the hands of the public.

I\’m afraid this is another example of Ritchie working from first principles and not realising that many have chewed over the same question before.

A temporary monetisation of the debt when the money multiplier has fallen is a good thing. That\’s why we do QE after all. A permanent monetisation of the debt just feeds through into inflation.

And booming house prices of course.

8 comments on “Ritchie really is going with this debt thing, isn\’t he?

  1. The Tories have learned from their early 90s housing crash: Falling house prices are a vote-loser. The logical conclusion is that if a particular policy has a side-effect of raising house prices, you can be sure they will pursue it.

  2. I tried explaining why monetisation should only be temporary on his blog but got slapped down and deleted, of course.

  3. Debasing the currency causes price inflation in imported goods, of course. It is therefore possible for deficit monetisation to cause some price inflation even in recession. If those imported goods are regarded as “essential”, people will cut discretionary spending to accommodate those price rises. I think we may be seeing this effect at the moment.

    Also, if those imported goods include items essential to the manufacture of products for export, then export prices could also rise – so Wiki is not entirely accurate in suggesting that debasing the currency makes exporting easier and improves the balance of trade. It depends how dependent manufacturing is on raw material imports.

    I tried pointing this out, too, but was told I don’t know anything about anything.

  4. I understand and accept all the points you are making, but could there not be alternative (preferable?) strategies available to the future reversal of QE? A tax on interest payments, perhaps, or increasing bank deposit requirements?

    I’m just thinking aloud, (and certainly not defending Ritchie!) so would appreciate any comments.

  5. The money multiplier is not going back to where it was for the foreseeable future – banks are not going to have leverage ratios over 30. So it will not be necessary to unwind all the quantitative easing.

  6. Rob,

    yes, we did. Was caused (imho) mainly by external supply shock (oil crisis) coupled with wage-price inflation because of the strength of the unions at the time. But loose monetary policy at the time probably contributed too.

  7. Nautical Nick, Paul B

    Really the money multiplier hasn’t got anything to do with this – if it even worked like that anyway. Reserve availability doesn’t constrain bank lending. Historically the central bank has always responded to demand for reserves by creating new base money – so increasing bank lending results in an increase in the monetary base anyway. Withdrawing QE money from the economy wouldn’t stop this happening but it would reduce the rate of growth of the monetary base.

    The main alternative to unwinding QE is of course significant rises in interest rates to encourage saving and discourage borrowing (and to support sterling, of course). But Nick I agree that constraints on lending such as leverage or deposit ratio limits could be effective as well.

    We should not ignore the effect on sterling that continual deficit monetisation would have. As a short-term strategy to support the economy in a recession it’s reasonable, but it isn’t an appropriate long-term strategy. Debasement of the currency destroys the value of people’s incomes and savings. Ritchie is very fond of Keynes – he should appreciate this, from Keynes’ book “The Economic Consequences of the Peace”:

    “Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.” […]

    “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

    (Quoted in Wikipedia’s entry on Stagflation http://en.wikipedia.org/wiki/Stagflation)

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