QE is fiscal policy

A new paper by Johnston and Pugh of the legal department of the University of Sheffield discusses the legality and the effectiveness of QE and its relatives, including the ECB's OMT "whatever it takes" promise.

The background to this is the German Constitutional Court's ruling that OMT amounts to monetary financing of government deficits and is therefore unlawful. Although the European Court of Justice is still to give its judgment in this matter - and is widely expected to dissent - the ECB is evidently doing its best to avoid outright QE, quite possibly because of questions over its legitimacy. The ECB has stated that in its opinion QE is legal, but then it said that about OMT too. The truth is that it is by no means clear that QE is legal in the Eurozone.

So the University of Sheffield's legal eagles have had a good look at the legality of both OMT and QE with respect to the Lisbon Treaty. And they concur with the German Constitutional Court. OMT does indeed amount to monetary financing of governments. So does QE. Both are therefore illegal under Article 123 of the Lisbon Treaty.

Article 123 of the Lisbon Treaty reads thus:

1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.

The UK has a specific restriction on the applicability of Paragraph 1 to allow it to continue to use the Treasury's existing "ways and means" overdraft facility at the Bank of England:

10. Notwithstanding Article 123 of the Treaty on the Functioning of the European Union and Article 21.1 of the Statute, the Government of the United Kingdom may maintain its ‘ways and means' facility with the Bank of England if and so long as the United Kingdom does not adopt the euro.

But in the view of Johnston & Pugh this does not exclude the UK from the GENERAL prohibition of monetary financing of fiscal deficits in Article 123. The "ways and means" overdraft was last used in 2008 at the height of the financial crisis: that borrowing has since been repaid and the UK has no current plans to use this overdraft facility. The question is therefore whether the Bank of England's QE programme has breached the prohibition of monetary financing to which the UK is subject as a signatory to the Lisbon Treaty. The Sheffield researchers think it has.

The reasons are not straightforward. Central bank purchases of own-government debt in the capital markets are not prohibited under the Lisbon treaty. Indeed they cannot be, because that would prohibit the main mechanism that EU central banks have historically used to control inflation, namely open market operations (sales & purchases of government debt) to maintain interest rates at a target level. This mechanism is currently in abeyance because of the presence of excess reserves in the banking system, but that does not mean it will never be used again in the future. QE also involves secondary market purchases of government debt. It is therefore easy to see QE as simply open market operations on a much larger scale. But the researchers argue that this is a misunderstanding of the nature and purpose of QE.

When government debt is purchased in a QE programme, the purpose is to control the market price of that debt. From the time that QE is announced until it is ended, the central bank effectively sets a floor on the price of government debt. This applies in both limited QE programmes, such as the Bank of England's, and unlimited, such as those in the US, Japan and Switzerland.

Forcing governments to fund themselves in the capital markets rather than obtaining funding from the central bank is supposed to ensure fiscal discipline. If governments over-spend, the thinking goes, capital markets will push up the cost of borrowing, forcing them to cut back spending and/or raise taxes. But if the central bank sets the price of government debt and stands ready to buy it in unlimited quantities, there is no discipline on the government. It can issue as much debt as it likes in the certain knowledge that there will always be a buyer. There cannot be a "buyer's strike" causing the price of debt to crash and yields to spike, as happened in Greece.

And this applies whether or not the central bank is actively purchasing securities. OMT has never been used - but its effect has been to force down yields on Italian and Spanish bonds, allowing their governments to maintain high debt/dgp levels without fear of default. There is no question but that the ECB did this to preserve the Euro. But it has undoubtedly also benefited the governments of those countries.

This is why the authors argue that QE is monetary financing of government deficits even though purchases are made from investors and banks, not directly from governments. QE amounts to an unlimited central bank credit facility. It is not the prohibition of government purchases that would be breached in an ECB QE programme, it is the prohibition of overdrafts and credit lines to governments.

And this raises a further issue. There has been huge debate about exactly how QE reflates the economy, though none of the explanations offered by economists and central banks have been conclusive: it has been claimed that QE influences the economy through portfolio effects (but substituting one safe asset for another doesn't have any effect on aggregate demand), suppression of the term premium (but it's probably very low anyway), increased liquidity in financial markets (doubtful, because QE contributes to collateral scarcity), increased bank lending (bank lending has been stagnant or falling), increased corporate investment (share buy-backs due to low borrowing costs are not investment). Most people agree that QE does support asset prices in a crisis, but its effectiveness as a long-term economic stimulus is questionable.

But the implication of Johnston & Pugh's work is that we have fundamentally misjudged the nature of QE. It has monetary effects, yes, but it is in reality a fiscal tool. It uses the central bank's ability to control market prices to enable governments to borrow and spend. This is why QE only works when the fiscal stance is expansionary. When the fiscal stance is contractionary - as it has been in most developed countries to varying degrees since 2010 - QE is ineffective.

Regarding QE as an enabler for fiscal expansion may explain a puzzle. Japan has by far the highest debt/gdp in the world, but it has very low borrowing costs. This can partly be explained by the fact that the Japanese are diligent savers, and much of their savings is held in the form of government debt: it could also perhaps be explained by the fact that investors are creatures of habit, retreating into traditional safe havens such as Japanese yen and JGBs when things get rough. But Japan has also been doing QE for far longer than any other country. Could the central bank's historical willingness to intervene in markets to control the price of Japanese debt be the reason why the JGB yield remains so low despite very high debt/gdp and poor economic growth?

But QE is also highly regressive. Doing fiscal expansion by the back door in this way virtually ensures that the money created does not go where it would have the most effect - it goes to those who least need it. The biggest beneficiaries of QE programmes are the rich, the value of whose assets rises when central banks intervene in this way - not just because the price of government debt rises, but because the price of other assets rises too due to substitution effects and the "reach for yield".

When government uses the central bank's suppression of bond yields as an opportunity to lock in low borrowing rates for the future and fund a fiscal expansion programme, then QE can be highly effective. But when governments fail to take advantage of central bank price control, QE can only benefit the economy through monetary channels which are both morally dubious and of questionable effectiveness. And when governments use QE as a cover for ill-considered fiscal austerity, QE actually transfers wealth from the poor to the rich. The weak monetary effects of QE might offset this effect to some extent, but the idea that QE can entirely negate the harmful effects of fiscal tightening in an economic downturn is not supported by the evidence. "Monetary offset" is a very nasty joke.

Johnston & Pugh's conclusion is damning:
In this paper, we have seen that, whilst QE can be argued to amount in substance to monetary finance, it is likely that the courts would not rule it unlawful. However, if a central bank did not offer justifications couched in monetary policy terms, there would be a much more serious risk of the intervention falling foul of Art 123 TFEU. The law’s emphasis on justifications and deference to central banks may not be surprising, but it does mean that there is scope for monetary finance so long as nobody admits that that is what is happening. It also means that arguably, monetary policy is outside the rule of law. It would be better for everybody if the debate was more open. 
So QE and OMT are illegal under EU treaties, but for political reasons no-one will ever admit that. This is the reason for the entirely artificial separation of monetary and fiscal policy, the monetary justifications for QE, the pretence that central banks are independent, and the charade of "fiscal discipline". The central bank must monetize debt, because the alternative is sovereign debt default and collapse of the currency: but if the central bank loses credibility, the currency is junk.

There is an elaborate charade whose sole objective is preserving the central bank's credibility. When central banks are monetizing government debt, it is the electorate, not the market, that controls the fiscal authority's propensity to borrow and spend. But if an elected government blatantly uses central bank debt monetization as an excuse for high borrowing and spending, the credibility of the central bank is toast. So everyone has to pretend that QE and its relatives don't fund the government, and politicians and voters have to be persuaded that restricting government's ability to borrow and spend is in their interests. The inflation monster is routinely invoked to terrify electorates into voting for austerity-minded politicians, and if that isn't enough, then the bond vigilantes and public debt bogeymen are called in too. And it works: not only have voters across Europe apparently been convinced that fiscal austerity is necessary even when it is clearly harming their economies, they have also been convinced that elected governments can't be trusted to manage public finances responsibly and must be restrained by unelected, unaccountable bureaucrats with their own political agendas. What an appalling erosion of democracy.

But debt monetization should not have to be a back-door exercise. In their concluding paragraphs, Johnston & Pugh call for an open debate about carefully considered outright monetization to end the disastrous austerity/debt deflation/higher debt/more austerity spiral in the Eurozone:
We have serious doubts about the efficacy of QE as a means to reflating the economy in the aftermath of a debt deflation.....Increased fiscal spending by governments would be more likely to be effective, but is currently ruled out by a belief that governments must pursue austerity in order for their countries to escape the crisis. We agree with Adair Turner that the time has come for a meaningful discussion about whether monetary finance offers a better way out of the current economic malaise, and if so, what form that monetary finance should take.
I have considerable sympathy for their argument, certainly for the depressed Eurozone periphery countries. Outright monetization is prohibited because of the fear of Weimar-style hyperinflation: but as I've explained before, hyperinflation is always and everywhere a consequence of political chaos and loss of trust. Provided that central bank credibility is maintained throughout, outright monetization of excessive legacy government debt burdens does not have to mean hyperinflation. There is still a need for fiscal discipline and structural reform going forward to ensure that debt, once relieved, does not build up again. But a one-off monetization of the debt burdens of the Eurozone periphery would do much to help Europe out of its seemingly endless slump.

Related reading:

Sacred cows and the demand for money
QE myths and the Expectations Fairy
Inflation, deflation and QE
Slaying the inflation monster
Rethinking the monetization taboo - Adair Turner
Have central banks been breaking the law? - Telegraph


  1. I like the claim by Adair Turner that “the time has come for a meaningful discussion about whether monetary finance offers a better way out of the current economic malaise.” That discussion has actually been taking place in Positive Money / New Economics Foundation circles for some time. Conclusions so far are:

    1. Giving both the central bank and fiscal authorities (aka politicians) a say in the total amount of stimulus makes as much sense as having a car with two steering wheels, each controlled by different people.

    2. Ergo, fiscal and monetary policy might as well be merged, i.e. when stimulus is needed, we might as well just create new base money and spend it (and/or cut taxes). That comes to the same thing as fiscal stimulus combined with QE.

    3. As to how to keep politicians away from the printing press, that’s easily done by having a committee of economists (much like the existing Bank of England Monetary Policy Committee) decide the TOTAL amount of stimulus, while strictly political decisions, like what proportion of GDP is allocated to public spending stays with the electorate and politicians. That is, the committee would tell politicians the amount by which government spending can exceed income in the next year or whatever, while leaving the decision as to exactly what to do with that money ENTIRELY up to politicians.

    1. "The committee would tell politicians the amount by which government spending can exceed income in the next year......"

      What a truly horrible idea. Unelected, unaccountable bureaucrats tell elected politicians what they can and can't do. Why not just abolish democracy and be done with it.

    2. If that's what you think, why aren't you vehemently opposed to the BoE MPC? The latter decides the amount of stimulus that is suitable. PM's committee would take EXACTLY THE SAME DECISION: i.e. it would decide what stimulus was suitable. The only difference is the WAY stimulus is effected. The BoE MPC implements stimulus via interest rate adjustments, QE, etc. PM's committee would implement stimulus by creating new base money and spending it. Indeed, given that QE involves creating new base money, that reduces the differences between two systems even further.

    3. As it happens, I do think the lack of democratic accountability of the MPC and the FPC is a considerable problem.

    4. Frances, I do like your claim that “I think the lack of democratic accountability of the MPC and the FPC is a considerable problem.” Was that made up on the spur of the moment in order to support the point you’re trying to make here, or have you long had reservations about the undemocratic nature of the BoE MPC? I ask because I’ve never seen you express such reservations. But perhaps I’m wrong: perhaps you REALLY HAVE expressed such reservations. So can you direct me earlier writings of yours where YOU HAVE expressed those reservations?

      Second, the idea that there are “considerable problems” in the undemocratic nature of the BoE MPC is too vague a charge to be of any use. OBVIOUSLY that committee is undemocratic, and equally obviously that’s a problem. But the alternative is to have politicians, 95% of whom couldn’t pass an elementary economics exam, take complex economic decisions. Anyone who thinks that’s not problematic is living in cloud cuckoo land. Moreover, you yourself point below to the serious problems involved in those wonderful democratically elected politicians taking economics decisions: as you rightly point out, they’ve backed austerity.

    5. Just because I have not expressed an opinion about the undemocratic nature of the MPC and FPC before does not mean that it doesn't concern me.

      There is not a single Minister in government who is an expert in his field. The experts - who are civil servants - are directed by and report to their elected masters. The Bank of England is the ONLY EXCEPTION to that, and it is all because of the charade of central bank independence.

  2. "As to how to keep politicians away from the printing press, that’s easily done by having a committee of economists"

    We already have a committee of unelected supposedly superior individuals. It is called the House of Lords. Why not simply repeal the 1911 Parliament Act and give them back the ability to veto the Budget of the Commons.

    Like they did in 1910 and caused a constitutional crisis.

    The elected body has to have sovereign power - because it is elected and answerable to the people. If they 'overspend' then they answer at the ballot box.

    A committee of 650 people in the House of Commons approve Budgets, and they can take sounding from whoever they choose. That is the correct platform to decide on the discretionary spending limits of the government.

    It is anti-democratic to suggest anything else.

    1. Delegating technical decisions to committees of experts is accepted by a large majority of the population and by a large majority of politicians as being a good idea. Thus delegating decisions on stimulus to the BoE MPC or the equivalent committee under PM’s system IS DEMOCRATIC. But just to formalise the latter point I suppose we ought to have a refendum on the point or perhaps a vote in the House of Commons on whether the BoE MPC should have any powers. But I suspect if you suggested such a vote to MPs or suggested a referendum, all and sundry would tell you to stop wasting their time.

    2. Fiscal austerity is also accepted by a large majority of the population and by a large majority of politicians as being a good idea. But that doesn't make it a good idea.

      Your proposal though is not delegation from elected politicians to committees of experts - it is the reverse.

    3. Frances, In your first para just above, you criticise the idea of having “majority of the population and . . . . a majority of politicians” take economic decisions. That contradicts your other claims above to the effect that that lot, rather than specialist committees should take economic decisions.

      Re your second paragraph, that’s just nonsense. You claim that I (and PM) want to have specialist committees “delegate” decisions to “elected politicians”. Quite the opposite: we want to have government, i.e. “elected politicians” delegate decisions to specialist committees, which to repeat, is a practice widely accepted as being desirable.

    4. I don't think you've read my post properly. I explained in the post why sometimes populations and politicians support ideas that are unhelpful or even harmful. They absolutely have the right to do so, but that doesn't make the ideas THEMSELVES a good thing. The job of informed minorities is to try to change the views of the majority so they make better decisions.

      Regarding the second paragraph - my comment referred to the fact that you apparently want an unelected technocratic committee with its own agenda to tell politicians how much money they can spend. That means that politicians would no longer be accountable to the electorate for the fiscal budget, only for its distribution. When money was too tight or too loose - which under your scheme it would inevitably be because of the inadequacy of information that we have discussed before, plus the technocrats' own priors - politicians can blame the economic consequences on the unelected technocrats, thereby escaping responsibility. To me this is unacceptable.

      Oh, and if you think technocrats' own priors don't influence their decisions, try reading the FOMC minutes from 2004 through 2008, as I did. It's a revelation.

    5. This comment has been removed by a blog administrator.

    6. Ralph Musgrave

      Your last comment has been deleted because it did not comply with the comments policy on this site.

  3. Someone seems to think that US QE 'worked' to a limited extent?

    "To me, that's really the key piece, because the impact that QE had on real estate is arguably the most effective part of this whole policy.
    I share a lot of the cynicism about the effectiveness of QE and whether it just expanded the wedge between the haves and the have-nots. But it clearly helped generate this recovery in real estate prices, which did lift 5.5 million households out of negative equity. That had a legitimate cash-flow impact, as these people could either sell their homes and relocate to find a job or refinance their mortgage, because suddenly their homes weren't underwater. So it had a legitimate, positive economic impact that you can quantify, to say nothing of the benefit to the financial sector."

    1. Propping up real estate prices immediately after the financial crisis was undoubtedly beneficial, though I think it would have been better to have offered direct support to struggling households rather than indiscriminate support to all households including the very wealthy. And don't forget that QE props the prices of ALL assets. The Bank of England found that the principal beneficiaries of QE were the very rich, and although they still defended QE as better than doing nothing they were clearly uncomfortable with its regressive nature. The Bank of England has since looked for other ways of providing monetary support to the economy - the Funding for Lending scheme, for example, which initially enabled banks to reduce mortgage interest rates and now specifically supports small business lending. And the Fed is ending QE even though the US economy is not growing as strongly as might be expected. Believe me, the central banks know that QE is problematic.

  4. The ECJ won't 'dissent' (that is what a minority judge does). They will overrule.

    1. Er no, the ECJ cannot overrule a sovereign constitutional court. Karlsruhe's judgment will still stand as far as Germany is concerned even if the ECJ rules otherwise. Therefore "dissent" is accurate, though maybe not the correct technical term (I am not a lawyer).

  5. There is no evidence that QE "only works when fiscal policy is expansionary" since nowhere that has employed QE has had austerity (name the year UK government spending didn't grow. Can't can you?). Two misunderstandings are confusing the issue for you. The first is that Japanese QE was conventional monetary policy, whereas King and Bernanke hid the very unconventional nature of what they were doing under the QE label in order to make people think they weren't doing anything the Japanese hadn't done before them; but they were. Second, it may have escaped everyone's attention, though the facts are there for all to see, that QE makes government debt more expensive (bond yields rise). Therefore QE can't be a way for the central bank to put a floor under the cost of deficits, etc - quite the opposite.

    1. Two huge fallacies in your comment, I'm afraid.

      Firstly, austerity does not mean cutting absolute government spending, it means reducing government budget deficits by means of spending cuts and/ or tax rises in order to reduce or eliminate the need to borrow. Government budget deficits have fallen - not as much as predicted, but that is because they are measured against GDP, which has not grown as much as predicted. When the denominator falls, the ratio rises.....

      Secondly, QE does not make government debt more expensive - it makes the cost of borrowing more expensive, which is not the same thing. QE does indeed raise yields to some extent, but that does not mean that the central bank is not setting a floor under the price. QE prevents a buyer's strike because the central bank is effectively underwriting government debt issuance - it is the buyer of last resort.

    2. Oh, and Japanese QE certainly wasn't "conventional monetary policy". It differed from Western QE in that its aim was to depress short rates, whereas Western QE aims to flatten the curve. The difference was because of learning from the Japanese experience. I would recommend reading the IMF's paper on Japanese QE. Of course Japan was not the first to do QE: the Fed used it in the Great Depression.

    3. You might want to revise that last paragraph Frances - you seem to have your yields and prices mixed up! Anyway, I don't think that you can say that QE puts a floor under the price of government debt. As its name suggest, QE has been defined in quantitative terms, either of the addition to the stock of reserves or the amount of debt purchased.

      Much though I dislike QE, or at least its maintenance so long after the financial crisis, I would dispute whether it is illegal, as long as governments do not buy government debt "direct" from finance ministries, but I would agree that this is a bit of a small fig leaf. Nevertheless, I would like to read the Johnston and Pugh paper myself to see how they make their argument, if you are aware of an ungated copy.

    4. Hi Tim,

      No I haven't got my yields and prices mixed up. QE is supposed to depress yields. The difference between "original" Japanese QE and Western QE is that Japanese QE was intended to depress yields at the short end of the curve, whereas Western QE was intended to depress yields at longer maturities while IOER propped up the short end - which flattens the curve. However, QE in practice seems actually to have raised yields on government debt - that is the point made by the first commentor.

      I absolutely can say that QE sets a floor under the price of government debt. The central bank stands ready to buy government debt at a price that it sets. The presence of the central bank in the market makes a buyer's strike impossible, since it is effectively the buyer of last resort, and as it is by far the largest player in the market, other agents will have to bid higher than the central bank's price if they wish to buy. If that isn't setting a price floor I would like to know what is.

      The SSRN link at the top of this post is ungated - download is free (at least it was to me and I don't have any special privileges as far as I know).

    5. You see, I believe the IOER was brought in to help re-capitalise the banks (once the authorities realised reserves weren't going to be deployed) and as an additional layer of control once we reach the far-end and banks come out of special measures. As it happens the Fed has also brought in the reverse repo facility, which is a more efficient way of re-directing bank lending away from the real economy if it starts to get too heated. Bank lending is now growing at a faster than 10% annualised rate, whilst QE is still in existence - hence the need (finally) for such dampening strategies.

      I also

    6. ...was not aware that the US had undertaken QE during the Great Depression. Do you have any links to articles describing exactly what they did? I'd be very grateful.

    7. IOER is too small to be regarded as bank recapitalisation, really. What HAS helped recapitalise banks is low interest rates coupled with regulatory tolerance of wide spreads. But even so, most banks have had to increase capital ratios by selling assets and, more recently, through rights issues.

      ONRRP targets non-banks not banks. Although it is a reserve drain, it would make little or no difference to bank lending - I've explained elsewhere why reserve changes don't make any difference to banks' ability to lend. It is possible that allowing non-banks to deposit funds at the Fed for a few basis points in interest might reduce non-bank lending to the real economy, though I think the effect would be marginal at most.

    8. Oh, and here's the St. Louis Fed on the 1930s quantitative easing (sorry, links aren't live, you will have to cut and paste into your browser)


    9. Frances, despite now saying that "QE is supposed to depress yields", you wrote above: "Secondly, QE does not make government debt more expensive - it makes the cost of borrowing more expensive, which is not the same thing. QE does indeed raise yields to some extent"

      I disagree about QE setting a floor under yields, at least officially. In general the central bank sets a quantity, with the implication that if that quantity does not lower yields enough for the government's liking, tough! If you think that "The central bank stands ready to buy government debt at a price that it sets", tell me what that price is for the UK or US.

    10. Tim,

      I'm not being inconsistent. The STATED PURPOSE of QE is to depress yields. But evidence shows that yields in fact rise during QE programmes.

      You know very well that I can't state what the price is. It is not "set" in that sense. But I don't think you've understood the point.

      The central bank's presence in the market is a price signal. The risk to governments from deficit spending is a buyer's strike, which can't happen when the central bank stands as buyer of last resort. So when the quantity of government debt the central bank is prepared to buy is unlimited ("whatever it takes"), the price of government debt is effectively supported by an unlimited central bank guarantee even if the central bank never actually buys anything. This is how OMT has depressed yields on Italian and Spanish debt, and why J&P argue that OMT amounts to monetary financing of government even though no purchases have been made.

      But the same guarantee holds even if the quantity is officially limited. After all, what CB is going to allow the price of its holdings of govt debt to crash? Therefore even though the central bank is officially only buying a given quantity, there is an implied commitment to intervene further if necessary to support the price. The "floor" is the price at which the CB would intervene to limit losses on its own holdings. It's a stop-loss, if you like.

    11. I see, although it is a bit hard to quantify the QE effect because speculation and announcement might have lowered bond yields beforehand.

      A central bank doubling up to limit the losses on its own holdings would be mad - Nick Leesonesque - but you may be right, such is the "Harlot's Progress" evolution of central bankers these days. I hope J&P have some impact.

    12. Thanks for the 1930s link Frances

  6. BTW, BoJ Governor Maasaki Shirokawa was not only fully aware that QE (as we define it) was fiscal not monetary policy, he also appreciated that it was regressive in nature. That is why Japanese QE was different to our version and why, now they have adopted Western-style QE they have had to give it a new name - QQE. James Ferguson, MaroStrategy Partnership

  7. So a sovereign debt jubilee but via balance sheet roll-up? And how long before private sector debtors vote themselves the same privilege? How long before everyone who pays taxes ponders the folly of having paid the things all along in the belief that there was some purpose or necessity to their contribution beyond income redistribution? If the maintenance of credibility in the system is the absolute essential component, I just don't see how that can be pulled off in reality.

    1. The people to whom QE redistributes income are the rich, and the rich are creditors not debtors. And the highest debt burdens fall on those on low to middle incomes, who have much less political power than the rich. Your notion that private sector debtors will "vote themselves" a debt jubilee is ridiculous. If they were going to do that they would have done so by now.

      Income redistribution is largely the purpose of taxation. I would dearly like to see more income redistribution to the poor and the highly indebted, though I would prefer it to take the form of higher wages rather than more benefits. But in the present political climate that is a distant dream - the combination of wage repression by employers and fiscal austerity by government is actually taking resources away from the poor and the highly indebted.

    2. Just playing devil's advocate, I wasn't making a case for QE at all. The commons may have less political power now, but they have far more votes and when push comes to shove that's what matters. As the late Steve Jobs said, people can't want what they don't know they can have. Don't you think the government establishing the precedent of washing away its debts would resonate to how people viewed the order of the whole system? Not that such a sea-change would objectively be a bad thing, but it certainly would be to the credibility and practical operation of the current system, i.e. failure of trust.

      I agree that income redistribution is largely the purpose of taxation, but I don't think most people do and I don't think most would want to continue paying if they saw the government getting off its debts seemingly scot-free, unless of course they either got to be a part of the jubilee or they got a nice fat handout too. But I suppose you'd agree with the latter in any event.

  8. "Outright monetization is prohibited because of the fear of Weimar-style hyperinflation: but as I've explained before, hyperinflation is always and everywhere a consequence of political chaos and loss of trust. Provided that central bank credibility is maintained throughout, outright monetization of excessive legacy government debt burdens does not have to mean hyperinflation. There is still a need for fiscal discipline and structural reform going forward to ensure that debt, once relieved, does not build up again. But a one-off monetization of the debt burdens of the Eurozone periphery would do much to help Europe out of its seemingly endless slump."

    A "one-off monetization" of government debt is not credible. Of course government will want to do it again and again. After QE1 comes QE2, and then QE-infinity.

    The French promised a "one-off monetization" and then did a second and third. And then the market realized this was going to go forever and they had hyperinflation.

    The political chaos and hyperinflation feed on each other and come in together. A government that can print money gets a lot of power from this ability. As they loose this ability the loss in power hurts all over.

    The French hyperinflation:

  9. Frances,

    what do you think of the argument (mainly put forward by monetarists) that monetary policy would be more effective if the central bank managed expectations in better way, either by promising to allow higher inflation than normal in the future (by keeping interest rates low for longer than normal), or by promising that an expansion of the monetary base will be permanent (effectively the same thing)..?

    1. Committing to keeping interest rates low until recovery is well established does help in my view, especially if there is a high level of private debt. This commitment supports agg demand, encourages deleveraging and provides some financial stability for households and corporates, enabling them to plan future investment.

      But the inflation arguments are typical monetarist mumbo jumbo. I dispute the equivalence between size of monetary base and inflation. And I disagree that the central bank adopting a higher inflation target necessarily influences inflation expectations. Inflation targets are a bit of a joke anyway, since for the last few years central banks have been "allowing" inflation well above target in the name of recovery and are now "allowing" inflation quite a bit below target. And no-one seriously thinks the expansion of the monetary base is temporary: excess reserves will be with us for the foreseeable future and the Fed has just announced a new policy regime (IOER/ONRRP) to work with them.

    2. you should do a comprehensive takedown of 'market monetarism' for your next post, including a critique of the inflation expectations theory...

    3. This comment has been removed by the author.

    4. I sort of already have....


      However, I could do a more technical dismemberment, perhaps.

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