Posted by: cjenscook | 02/25/2010

QE or not QE?

This letter by Professor Roger Sandilands of Strathclyde University was published on Tuesday in the Financial Times.

Sir, The focus of all three letters by some 80 or so distinguished economists – a majority of a Keynesian bent – has been on when to initiate fiscal retrenchment. There has been little mention of the method of financing.

In the 1930s, John Maynard Keynes’ friendly adversary, Sir Ralph Hawtrey, insisted that deficit finance would not normally be needed as a counter-cyclical weapon so long as the potentially unstable money supply was kept under firm control. However, in the event of poor control followed by an unusually severe depression like today, Hawtrey diagnosed what he called a “credit deadlock”, in which a collapse of confidence made banks fear to lend to the private sector and the private sector fear to borrow from the banks.

In such conditions he agreed that fiscal policy should come to the rescue to break the deadlock. But he also insisted that its effectiveness depended crucially on how the deficits were financed. If the private sector is frantically de-leveraging, as today, fiscal deficits lose much of their effectiveness if paid for by increased private saving.

Therefore what is needed is for government to expand the money supply (hence net monetary expenditures) by itself spending an adequate amount of newly issued money directly into circulation rather than borrowing from the existing (and declining) circulation. This borrowing from the private sector adds unnecessarily to the national debt.

Quantitative easing will not do the trick if the Bank of England’s net purchase of debt from the private sector largely ends up as increased bank reserves. That is why the money supply in circulation (this excludes bank reserves) has registered sluggish, sometimes negative, growth through our deep recession. And that is why recovery has been equally sluggish despite a soaring public debt.
Yours etc

As I pointed out in my last post on Labour List, most people, and the vast majority of economists, are under a misapprehension as to the nature of the £200bn of Public Credit which is being deployed by Mr Darling to buy Treasury debt (gilts) with the aim of injecting money into the economy.

This has acted as a transfusion of public credit to replace the bleeding of private credit implicit in the non-performance of hundreds of billions of bank loans. Although QE has been paused briefly, Mr King seemed to recognise in his recent appearance before the Treasury Select Committee that the transfusion would soon need to be resumed.

Unfortunately, as is implicit in Professor Sandilands argument, all QE currently achieves is to inject public credit/money to keep the largely unproductive, and for the most part parasitic, financial ‘bubble economy’ pumped up. It does nothing to address the problems in the real productive economy of the public and private sectors. Note here that the Public sector is ‘unproductive’ only from the peculiarly selfish view of the shareholder: from the perspective of the entrepreneur, supplier, customer, management and staff, it is the shareholder who is unproductive.

As the Professor points out, the requirement is for the government to spend money into the economy and to fund the deficit with QE. In my view, this process should be carried out through the creation of local Treasury Branches – as in Alberta, Canada – and for massive investment in the forms of capital recently identified by Mark Dominik.

This investment of literally £ hundreds of billions in productive assets (and people!) should be professionally managed by service providers in such a way – I advocate a revenue sharing approach – that they have a stake in the outcome. In fact, such banking service provision would be in the interests of banks as they no longer need to risk their capital by creating credit based upon it.

The public credit creation process would be overseen by a Monetary Authority – a function for the Bank of England – to ensure that the economy does not overheat.

For 300 years governments have delegated to private banks the creation of the credit necessary for the circulation of goods and services and creation of productive assets. Since the current position is that, due to shortage of capital, private banks cannot or will not do so, then in my view Mr Darling must simply write cheques on the Treasury’s account with the Bank of England to fund the necessary investment.
Once productive assets have been developed – such as affordable housing, or renewable energy – then any resulting revenue streams would be well suited for long term investment eg by pension funds, and this investment would then allow the QE development credit to be recycled.

Mr Darling should act immediately in accordance with the Professor’s advice to invest money directly into the economy: that should be the Chancellor’s job.

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Responses

  1. What Professor Sandiland is advocating is described by the IMF’s DCE equation which links changes in the money supply to the way the PSBR is funded – the mechanics of which were imposed by the IMF on Healey in the ‘70s (in reverse) to reduce the money supply.

    I think this is how it goes … If the Government pays a nurse’s monthly wage with a cheque on its account at the Bank of England, the nurse then takes the cheque to his bank. The nurse’s bank presents this cheque at the Bank of England. A deposit has been created. Up goes the money supply because of this increase in Private Sector Lending to the Public Sector.

    If the nurse spends this ‘new’ money then AD as been affected. If the nurse uses the funds to pay off an extra amount of his mortgage down goes the money supply because of the decrease in Private Sector lending to the Private Sector).

    However, if this procedure is used for investment spending by the Government on infrastructure (as the Professor advocates) this would create at least one round of spending on material, a legacy of increased capacity and, if spent on particular projects, some social and economic gains. If this action is supported by a communications campaign around a National Recovery Plan to raise optimism and show a sense of purpose it should affect positively firms’ willingness to invest/restock and the population’s propensity to consume.

    There were plenty of important public/private infrastructure projects with planning permission and at the ready which faltered and were shelved in late 08, so lags in getting this approach up and running would have been minimal.

    It could be that the reason the Governor of the Bank of England promoted QE was because he thought it would be more easily reversed and would not run the risk of reintroducing politicians to this potentially (in other times) inflationary and superficially attractivew way to finance its spending.

    Possibly we are already too late for the politics to bear this approach now. If so, history could judge Brown and Darling’s willingness to go along with QE (rather than this more direct way of increasing aggregate demand) as their greatest mistake and a tragedy for the nation.

  2. […] Chris Cook argues for  stimulation of the UK  economy by issuance of money by government to find productive projects directly – bypassing the banks.  The Irish government an delectorate has ceded this power to the ECB under Maastricht, unfortunately.  But the argument builds that the Irish government should join with fellow PIIGS to lobby the ECB to make a trillion euro distribution on a per capita basis  to all EMU governments, as Marshall Auerbach suggests. …In the 1930s, John Maynard Keynes’ friendly adversary, Sir Ralph Hawtrey, insisted that deficit finance would not normally be needed as a counter-cyclical weapon so long as the potentially unstable money supply was kept under firm control. However, in the event of poor control followed by an unusually severe depression like today, Hawtrey diagnosed what he called a “credit deadlock”, in which a collapse of confidence made banks fear to lend to the private sector and the private sector fear to borrow from the banks. In such conditions he agreed that fiscal policy should come to the rescue to break the deadlock. But he also insisted that its effectiveness depended crucially on how the deficits were financed. If the private sector is frantically de-leveraging, as today, fiscal deficits lose much of their effectiveness if paid for by increased private saving. Therefore what is needed is for government to expand the money supply (hence net monetary expenditures) by itself spending an adequate amount of newly issued money directly into circulation rather than borrowing from the existing (and declining) circulation. This borrowing from the private sector adds unnecessarily to the national debt. Quantitative easing will not do the trick if the Bank of England’s net purchase of debt from the private sector largely ends up as increased bank reserves. That is why the money supply in circulation (this excludes bank reserves) has registered sluggish, sometimes negative, growth through our deep recession. And that is why recovery has been equally sluggish despite a soaring public debt…(link to article) […]

  3. […] Prof Roger Sandilands 2010 in FT Sir, The focus of all three letters by some 80 or so distinguished economists – a majority of a Keynesian bent – has been on when to initiate fiscal retrenchment. There has been little mention of the method of financing. […]


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