Comments on: A Chicago-educated Professor denies the problem of strained balance sheets leading to the paradox of thrift

By: freethinkingeconomist

freethinkingeconomist — Mon, 09 Nov 2009 16:12:09 +0000

Thanks for these, chaps: sometimes I think I’m the only person this side of the pond reading Prof Sumner, and reading all those “how right you are” comments at the bottom makes me feel awful lonely in being a sole voice thinking “This can’t be this easy”.

Though I think he would have a valid answer for the Bank of England’s QE failing, and it is one that I would use too: the Bank’s determination to not lose its virtue – “we honestly won’t let inflation rip, honestly . . ..” means that their effect on ordinary punters’ motivation is unlikely to be large, because as SS says monetary policy works as much by influencing the whole future path of interest rates and prices, than just the current conditions. In other words, QE is being presented as a temporary loan of £200bn that will be pulled back pretty fast and with little warning: in which case, why should I do anything but stick the money in other liquid assets?

I also think (2) is weak. Our biggest capital splurge was 1988-89, when rates were pretty high. The cost of the funds seems a pretty poor driver compared to sheer animal spirits, asset price expectations, and so on.

I’m with Chris on (1) being really weak. Suppose I had bought a house for £1m and the value had fallen by £300k, putting me £200k into negative equity. I would use every spare bit of cashflow to repay the debts to get me out of negative equity, regardless of interest rates. And I doubt very much that just because I’ve repaid debts, someone else will get the cash and have the same propensity to consume with it. Consumption falls, I’m sure.

David, I’m a pragmatist too: which is why I think QE needs some combination with Fiscal policy to really work. It needs some inkling that the Bank may be about to be mildly debauched, that some of the new cash will be actually USED, immediately, in the economy, that the Bank will not rest until growth (NGDP?) is resumed. I think that ‘in the foxhole’, faced with the immediate consequences of state actions, any finance minister would want a mixture of both policies just to make sure we don’t get 1931 all over again. It’s fine for academic scribblers to shout about just one club; the guys in control have to use every one in the bag.

Paul, my intuitions are there with yours. The households you no doubt meet in Lancs are unlikely to be going on a splurge just because of QE, are they? Money is being used to repay debts, and the money so released is not being used to consume.

By: David Heigham

David Heigham — Mon, 09 Nov 2009 15:56:34 +0000

A decade or two ago, I thought that we had all come to a concensus that central banks expanding money supply could enable economic expansion; but that the tension to take up the slack had to come from somewhere else. The purer montarists maintained that in almost all circumstances, the tension would be there as resultof the normal functioning of markets. Purer Keynesians (as opposed to those simply inspired by Keynes) maintained that the normal functioning of markets, if it worked at all, could rarely be relied upon to work promptly. The bulk of us pragmatists doubted that pushing on a piece of monetary string would be very effective; and noted that repeated fiscal stimulus generated more nominal expansion than real expansion.

Scott Sumner appears to have dredged a relic of the pure monetarists faith out of his sub-conscious while struggling with the thought that money fixed in balance sheets need not affect inflation. The logical policy conclusion from his thoughts would seem to be a version of helicopter money: shove the newly created money directly into economic agents’ balance sheets and all will be well. However, he shies away from that conclusion – whether because there is no way known to make the policy work; or it violates his shibboleths; remains undetermined.

By: chris

chris — Mon, 09 Nov 2009 13:22:04 +0000

I think your interpretation is right.
The question is: how would OMO generate economic activity at a time when households are increasing their savings? There are three possibilities:
1. It deters the rebuilding of savings in the first place. If households expect faster monetary growth to lead to higher inflation, they’ll spend more now, partly to beat the price rises, partly because they will be content with higher debt, as this’ll be eroded by inflation.
2. Lower interest rates encourage capital spending.
3. Printing money depresses the exchange rate and boosts exports.
My hunch is that 2 and 3 are weak mechanisms. And 1 doesn’t seem to have worked, perhaps because households’ inflation expectations aren’t monetarist (maybe rationally so, if you believe Adam Posen as I do), or perhaps because demand expectations are depressed.
I share your scepticism about the ability of central banks to maintain demand.

By: paulinlancs

paulinlancs — Mon, 09 Nov 2009 10:32:58 +0000

Interesting, Giles (not sure which Paul you’re referring to but I’ll have a crack anyway).

No, I don’t get it either. As a non-economist , the ‘real life’ , micro-economic need for households to be in a position to ‘demand’/consume more before growth properly takes hold has always seemed an intuitive sine qua non to me, and actually one of the key arguments against public service cuts (meaning less low/middle income people in stable work) – one of the clearest anti-cuts arguments to ‘sell’ on the doorstep too, incidentally.

I may be wrong in my economics logic here, but I think this takes us back into the territory of an interchange between Duncan W and Tim W, with me hanging on the coat tails, a few months back around the validity of the IS/IM Keynesian model, and some of the Duncan did intend to do, but never had time for (v understandably),around reclaiming the Hobsonian thesis of underconsumption for the 21st century (with a Joan Robinson/Minsky slant around class and equity??).

But I may simply have got that wrong. Also seem to remember that John from Post-Keynesian Observations had some interesting views around this area (on the same comments thread?) but again memory is hazy.

So your sardonic ‘notion’ of conviction might be replaced by a more socialist notion of ‘redistrubitive’?

Over to Chris, Duncan, another Paul……