Simon Carr at the Oldie, among others, seems mystified as to why we can have quantitative easing – which appears to be a magic money tree – and yet not a magic money tree to pay for everything that John McDonnell wants to buy to bribe the electorate. Another way of putting this question is, well then, why won’t Corbynomics, or Peoples’ Quantitative Easing (to use Richard Murphy’s name for this) work then?
One answer being that Richard Murphy is a retired accountant from Wandsworth not an economist. That seems to be insufficient reasoning to some even though McDonnell himself has been distinctly less than complimentary about Murphy’s economic knowledge.
Another possible answer is that this is important so you’d better go find out Carr. After all, as you say, an election could hinge upon this and in a democracy it’s the voters who have to get up to speed on this stuff. It’s our job to understand who is lying to us and who is not. You know, we’re the citizenry making the decision and all that.
At which point, the economics of this in baby steps.
The Magic Money Tree is the idea that the government can just print lots of money and then go and spend it. There’s no financial constraint upon government that is. They don’t have to worry about taxes to fund buying lots of lovely things for us voters. They just get the Bank of England to print more and then everything, but everything, can just be paid for. This is also the central claim of Modern Monetary Theory.
It’s correct. Government can do this. Many governments have done this. Henry VIII did it in Britain. OK, he did it in a slightly different way but it was indeed the same thing, he debased the silver coinage. Which is indeed the same thing, add 50% copper to the silver and you’ve twice as much money which government can then spend. His children spent much of their reigns trying to deal with the effects.
The effect being inflation of course. More money around did not increase the number of things around which could be bought. More shillings and the same number of things just meant that each thing cost more shillings. Inflation in short.
(Interlude – do note that central banks do increase the amount of money around each year. But they only increase it by the amount of more things there are around as well. A growing economy needs more money in exactly the same way that as a restaurant gets busier it needs more plates to put the food upon. But that growth in money should be at the speed the economy is growing itself, no faster)
At around and about the same time Spain also did much the same thing. All that gold and sliver from Latin America flowed into Spain. Spain didn’t have any more land, sheep, people, or anything else as a result, just more gold and silver. Thus prices rose in relation to that more abundant gold and silver. This inflation flowed across Europe.
Other historical episodes include the Weimar inflation, the Hungarian Pengo and in more recent times Zimbabwe – where they kept printing money until the last run of hundred trillion $ bills weren’t worth enough to buy the ink for the next run – and Venezuela.
Government can therefore just print money and go and spend it. This has an effect. Inflation.
Another name for this in the technical jargon is monetisation of fiscal policy. There’s a reason why it’s banned (yes, banned) under the eurozone rules. For we’ve a number of countries and governments all of which share the same currency. Any one of them could print more euros and go and spend them. This would be great for that specific country. They’d get to spend lots without having to tax. But the inflation would be carried by all the countries in the currency bloc, not just the one doing the printing. The incentive therefore would be for everyone to do as much as they could before anyone else did.
This is what actually happened after the break up of the Soviet Union. Each new country had a printing press which produced entirely legal rubles. So they all printed masses and whoo!, didn’t they all have inflation?
So, just printing more money leads to inflation. The more money printed the more the inflation is.
The Modern Monetary Theory answer to this is taxes. If you print lots of money to spend and then spend it then you can tax that extra money back. Which indeed you can. And look what happens then.
You’ve a high spending government which is taxing lots. The end result here is just Old Labour again, high taxes, high spending. More of the economy flows through government and we’re not anywhere different from when Healey was squeaking pips.
The basic idea just isn’t new. The results are predictable – and the way politics works no one will ever tax enough to stop the inflation. Spending is fun, taxing not so much. Which is why it always has led to inflation on a roaring scale.
So what about this quantitative easing then? This is just the same isn’t it? The Bank of England has just invented money and gone out and spent it, hasn’t it?
Yes, but with three little caveats.
The first is that we wanted to create inflation, which we did, so that’s good.
The second is that the BoE didn’t spend it, it’s just sloshing around the markets instead.
The third is that it’s reversible. And if we don’t reverse it then the inflation will come in a roar.
Baby steps, baby steps……but we have several different kinds of money. Various names, base and wide money, or the jargon of M0, M1, M4 and so on, or low powered and high powered, or if you prefer actual money and then credit. M4 is credit, wide money, low powered money, largely, M0 is base, high powered or even just money money.
You’ll have seen the claim around that 95% of all money is just created by the banks when they make a loan. Sorta, ish-ish, true. 95% of credit, or wide money, or low powered money, is created by the banks. 100% of narrow, high powered, money is created by the Bank of England.
The Bank of England creates notes and coins, that M0, (yes, it gets more complex but baby steps). Then we all go and use it, spend it, save, it, stick it in banks, borrow it, lend it, all sorts of things, and the net result of all of this is that wide money measure, M4. The difference between the two is the money multiplier or, in the jargon, V, the velocity of circulation (yes, I know but look, baby steps).
This difference is significant. Before QE the UK’s M0 was of the order of £50 billion. M4 was a couple of £trillion. Not the right numbers but about right, in magnitude at least.
After QE M0 is about £450 billion, M4 is still a couple of trillion.
Note that inflation is determined by M4, not M0. M4 hasn’t grown which is why we’ve not got massive inflation as a result of QE. So, why haven’t we?
Because our entire problem was that V, that velocity of circulation, or the amount of stuff that we did with the money the BoE was creating, fell massively as a result of the financial crisis. This is the central economic analysis of what happened by the way, which is why all the central banks did go and do this QE. And if that V falls, and we’ve the same amount of M0 around, then M4 will fall – and that’s the opposite of inflation, that’s deflation. What happened in the 1930s turning a nasty recession into the Great Depression (yes,that is now the standard analysis, Milton Friedman was right here). So, we print lots of M0, that’s the BoE inventing money in the basement, and we don’t get inflation. which is what actually happened. Great.
But what happens when V recovers? When we all start to borrow and save and move money around like we used to? That old relationship between M0 and M4 will revive and thus M4 will soar (we’ve 10x as much M0 as we used to) and so will inflation.
Which is where the difference between QE and magic money tree is. The BoE quite deliberately did not spend that new money into the real economy. It was used to buy bonds, mostly Treasuries. This lowered interest rates, a little bit, which is nice. But the big thing is that when (OK, if) we get back to normal now we can reverse things. We can sell those bonds, collect that money we created earlier, feed it back into the computers in the basement and cancel it. We thus bring down M0 but not M4 (recall, we think our multiplier between these two is recovering) and thus have we avoided deflation for a time but without creating inflation for the long term. Note that the Federal Reserve, just last week, announced the schedule it will use to do this. There is no mystery to what I am saying, this really is how this system works.
Magic money would be spent into that real economy. We cannot get it back again when inflation starts to arrive. Well, we can, but only at the price of extortionate tax levels. Which, as above, means that using the magic money tree to really spend just means higher taxes a la Old Labour. Not so magic, hunh?
At which point, the difference between quantitative easing and the magic money tree. QE is temporary, reversible, and is a tactic of last resort to prevent deflation and thus a depression. It works but it must, at some point, be reversed. If it isn’t reversed it will cause significant inflation. Two and three digits a year sort of inflation.
The magic money tree is permanent spending of the same invented money, it is not temporary – the effects are permanent – and it is not reversible without stinging tax rates. It is also known as the monetisation of fiscal policy, or the monetisation of spending. And it has everywhere and everywhen been a disaster from the point of view of subsequent inflation. Not inflation of a couple of percent here and there either, but of two and three digits a year sort of inflation.
That is, the effects of just making more money are the same either way, in the end at least. But QE can be reversed to stop it, the magic money tree cannot.
For the end effect of the magic money tree see the Hungarian Pengo.
And now to British politics. John McDonnell’s going to stop spending all that newly invented money to stop the inflation that’s going to arrive in 18 months time. Isn’t he?