The official view, as articulated by Ben Bernanke, chairman of the Federal Reserve, is that both the first Great Depression and the current crisis were caused by a lack of base money. Base money, or M0, is money that the central bank creates. It forms the reserves held by private banks, on the strength of which they issue loans to their clients. This practice is called fractional reserve banking: by issuing amounts of debt several times greater than their reserves, the private banks create money that didn\’t exist before. Conventional economic theory predicts that when the central bank raises M0, this triggers a \”money multiplier\”: private banks generate more credit money (M1, M2 and M3), boosting economic growth and employment.
Bernanke, echoing claims by Milton Friedman, believed that the first Great Depression in the US was propelled by a fall in the supply of M0, which, he said, \”reinforced … declines in the money multiplier\”. But, Keen shows, there is a weak association between M0 supply and depression. There were six occasions after the second world war when M0 supply fell faster than it did in 1928 and 1929. On five of these occasions there was a recession, but nothing resembling the scale of what happened at the end of the 1920s. In some cases unemployment rose when the rate of M0 growth was high and fell when it was low: results that defy Bernanke\’s explanation. Professor Keen argues that it\’s not changes in M0 that drive unemployment, but unemployment that triggers changes in M0: governments issue more cash when the economy runs into trouble.
President Obama justified the bank bailout on the grounds that \”a dollar of capital in a bank can actually result in eight or 10 dollars of loans to families and businesses. So that\’s a multiplier effect.\” But the money multiplier didn\’t happen. The $1.3 trillion that Bernanke injected scarcely raised the amount of money in circulation: the 110% increase in M0 money led not to the 800% or 1,000% increase in M1 money that Obama predicted, but a rise of just 20%. The bail-outs failed because M0 was not the cause of the crisis.
Jeez. It\’s as if MV = PQ never existed, isn\’t it?
Sure there\’s a multiplier, sure there\’s a V, the velocity of circulation.
But V changes in recession. So, in a recession we need a greater increase in M to stop declines in either P or Q.
Keen hasn\’t discovered anything new, he\’s simply ignoring (or ignorant of) the conventional wisdom.
If V were constant and we pumped $1.3 trillion of new Mo into the economy then we\’d have hyperinflation! Because we would have created $8 trillion or whatever of new wider money supply.
As to the rest of Keen\’s thesis, excess debt leveraging, sure, this is pretty much the Austrian view, you know, Hayek, Mises etc. Hardly new.
Instead, Keen says, the key to averting or curtailing a second Great Depression is to reduce the levels of private debt, through a unilateral write-off, or jubilee.
And no, that ain\’t the solution. We want to liquidate the unproductive debts, the stupid stuff, but not the good stuff. So we want bankruptcy of those who cannot pay, not simply the wiping away of all debts.