{"id":6617,"date":"2009-12-13T14:14:03","date_gmt":"2009-12-13T04:14:03","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=6617"},"modified":"2009-12-13T14:14:03","modified_gmt":"2009-12-13T04:14:03","slug":"more-quantitative-easing-will-not-expand-credit","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=6617","title":{"rendered":"Building bank reserves will not expand credit"},"content":{"rendered":"

\t\t\t\tIn his latest New York Times article (December 10, 2009) – Bernanke’s Unfinished Mission<\/a> – Paul Krugman reveals that he doesn’t really understand much about macroeconomics. Sometimes you read a columnist and try to find extra meaning that is not in the words to give them the benefit of the doubt. At times, Krugman like other columnists sounds positively reasonable and advances arguments that are consistent with modern monetary theory (MMT). But then there is always a give-away article that appears eventually that makes it clear – this analyst really doesn’t get it. In Krugman’s case, he doesn’t seem to have learned from his disastrous foray into Japan’s “lost decade” policy debate.
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\nIn the late 1990s, Paul Krugman joined a number of academic economists in urging the Bank of Japan to introduce large-scale quantitative easing to kick start the economy. The Bank, reluctantly, heeded their advice and in 2001 they increased bank reserves from \u00a55 trillion to \u00a530 trillion. This action had very little impact – real economic activity and asset prices continued their downward spiral and inflation headed below the zero line.<\/p>\n

Many economists had also claimed that the huge increase in bank reserves would be inflationary. They were also wrong. Please read my blog – Balance sheet recessions and democracy<\/a> – for more discussion on this point.<\/p>\n

In this 1998 article<\/a> on Japan’s trap, Krugman claimed that Japan was “in the dreaded “liquidity trap”, in which monetary policy becomes ineffective because you can’t push interest rates below zero”. This is similar to the argument he is making about the US at present.<\/p>\n

He said that when the nominal interest rate is at zero and therefore stimulatory interest rate adjustments can no longer be made, the real rate of interst that is required to “match saving and investment may well be negative” (as an aside – this sort of reasoning is derived from the highly flawed loanable funds doctrine).<\/p>\n

As a Keynesian, he recognised that there was a spending gap in Japan at the time and while fiscal policy would possibly work it is constrained by “a government fiscal constraint” and further that the Japanese Government would only be wasting its spending on “roads to nowhere”.<\/p>\n

So he then considers monetary policy as the best way forward. In that context, Krugman says that the nation needs a dose of expected inflation so that the real interest rate becomes negative (and flexible). He concluded that monetary policy had been ineffective because:<\/p>\n

\n… private actors view its … [Bank of Japan] … actions as temporary, because they believe that the central bank is committed to price stability as a long-run goal. And that is why monetary policy is ineffective! Japan has been unable to get its economy moving precisely because the market regards the central bank as being responsible, and expects it to rein in the money supply if the price level starts to rise.<\/p>\n

The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible – to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs.<\/p>\n

This sounds funny as well as perverse. … [but] … the only way to expand the economy is to reduce the real interest rate; and the only way to do that is to create expectations of inflation.\n<\/p><\/blockquote>\n

So he was completely wrong in this diagnosis. The only thing that got Japan moving again in the early part of this Century was a dramatic expansion of fiscal policy.<\/p>\n

In another related article Krugman elaborated on quantitative easing<\/a>. He said:<\/p>\n

\nThe Bank of Japan has repeatedly argued against such easing, arguing that it will be ineffective – that the excess liquidity will simply be held by banks or possibly individuals, with no effect on spending – and has often seemed to convey the impression that this is an argument against any kind of monetary solution.<\/p>\n

It is, or should be, immediately obvious from our analysis that in a direct sense the BOJ argument is quite correct. No matter how much the monetary base increases, as long as expectations are not affected it will simply be a swap of one zero-interest asset for another, with no real effects. A side implication of this analysis … is that the central bank may literally be unable to affect broader monetary aggregates: since the volume of credit is a real variable, and like everything else will be unaffected by a swap that does not change expectations, aggregates that consist mainly of inside money that is the counterpart of credit may be as immune to monetary expansion as everything else.<\/p>\n

But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.\n<\/p><\/blockquote>\n

So once again he is claiming that an expansion of reserves will increase bank loans because he asserts it will be inflationary and alter the drive the real interest rate into the negative domain.<\/p>\n

More recently, Krugman wrote – It’s the stupidity economy<\/a>. Once again when you read this article you appreciate how far Krugman is from understanding modern monetary theory (MMT), which means he really doesn’t get the way the fiat monetary system works.<\/p>\n

His options of how to deal with the ineffectiveness of monetary policy are, in his order of preference, which just rehearse his earlier work in relation to Japan:<\/p>\n