Krugman, Bowman and the monetary financing of governments

Krugman says central banks can't create inflation. When interest rates are at zero, expanding the monetary base makes no difference.

This is, of course, anathema to dedicated believers in the omnipotence of central banks. But Krugman is in good company. I recently heard Richard Koo speak on lessons from Japan for the Eurozone. Koo questioned QE's effectiveness when the private sector is refusing to take on more debt because it is determined to deleverage.

Koo's and Krugman's scenarios are actually the same, though they attack the problem from different angles. In both cases, interest rates are zero, though Krugman explains this as an infinite demand for interest-free money (the liquidity trap), and Koo explains it as a lack of demand for borrowing. Both argue that central banks are unable to generate inflation when the private sector does not wish to spend. Both insist - though for different reasons - that when interest rates are zero, fiscal stimulus is needed to get the private sector to spend. 

Sam Bowman thinks this is absurd:

Let's test out Sam's theory. Imagine a country in which there is a fiat currency but no central bank. Money is directly created by government and paid to the population as a basic income via commercial bank accounts in a free banking system (Sam will like this!). People spend that money on goods and services, enabling businesses to flourish and creating jobs, which in turn enable people to top up their basic income with earnings. People get richer, and they spend more. The government keeps on printing money to provide the basic income, even though people are earning more and more from their jobs. Soon the place is awash with money. People can buy all they need and save as much as they want, and still have money left over. It's an earthly Paradise.

Except that it isn't. When everyone has everything they could possibly ever need, money is worthless. Money is only valuable to the extent that it is scarce relative to goods and services not only now, but for all time: as long as there is (relative) poverty, and therefore demand for money, money has value. Inequality is necessary if money is to maintain its value. This is why measures to reduce inequality, such as transfer payments from rich to poor, can be inflationary. But when the government prints more and more money, dishes it out as helicopter drops to everyone equally, and never taxes any of it away, goods and services become scarce relative to money, and therefore more valuable. If people start to believe that the supply of money is infinite, goods and services become infinitely valuable. Please note that this is NOT the same as Krugman's liquidity trap. In a liquidity trap, the demand for money is infinite, not the supply. What I am describing here is Zimbabwean hyperinflation. Central banks may not always be able to generate inflation, but governments can.

So to control inflation, the government needs a mechanism to drain money from the private sector. It could do what central banks do, namely sell assets. But what assets does it have? It might have some physical assets - schools, hospitals, roads, that sort of thing. But once it has sold those, what then? Well, it could issue bonds. We aren't used to thinking of government bond issuance as a monetary tool, but there is no reason why it should not be. If a government issues bonds but does not spend the money received - as researchers at the Bank for International Settlements have suggested - then money is drained from the private sector. Government bond issuance is monetary tightening. Private sector saving in the form of government deposits is also monetary tightening for the same reason.

In this scenario, there is no need for taxes. Government spends using newly-created money, then neutralises that spending by issuing bonds to the private sector. Interest rates are high enough to ensure that the private sector voluntarily buys enough of them to sterilise the Government's spending - though if the private sector's propensity to save is high, as in Koo's scenario, this could still mean interest rates at or close to zero. It's entirely circular and not inflationary. In theory, therefore, government spending could be entirely sterilised with bond issuance and/or private sector deposits (are you listening, Japan?). Note that spending comes first, just as bank lending precedes deposits. Governments really can act like banks.  

However, it is entirely possible that the private sector might refuse to buy the bonds. After all, they are only a promise that some future basket case government will redeem them by printing worthless money. Without something a bit more definite than "we really will pay you this money, honest", the private sector might balk.

This is where taxes come in. In a fiat currency system, taxes are a means of forcing people to return money to government. They are, if you like, the equivalent of required reserves for banks. Everyone must place a certain proportion of their income on deposit at government: the greater their income, the more they must place on deposit. People who refuse to maintain these "required reserves", or who divert them to other purposes, can be fined or jailed. In this way government ensures that it can always sterilise its spending.

In our mythical fiat-currency, free-banking, money-financed country, taxes - or at least the threat of taxes - would be necessary to control inflation. Just as a credible central bank standing ready to buy assets sets a floor under the price of those assets, maintaining their value, so a government that can credibly impose taxes on its population maintains the value of the currency, both now and in the future (this is why the power to tax also supports the price of government bonds). A defining feature of hyperinflationary episodes is that government loses the power to tax. It can print money, but it can't recall it. Central banks use interest rates as a proxy for taxes, but if the government loses its credibility then all too often the central bank does too - in which case interest rates lose their potency. In 1998, interest rates at 160% failed to restore the Russian currency or prevent government default.
The point of this rather fanciful example is that a credible government can in theory finance its own spending without a central bank. "Borrowing" and taxes are both ways of sterilising money financing of governments. Governments do not need central banks to control inflation. They can control it themselves.

So why is money financing of government feared? It is feared precisely because it is far more likely to be inflationary than money creation by an independent central bank. Krugman is right. Central banks simply are not as effective at creating inflation as governments. If they were, we wouldn't entrust them with management of the money supply. After all, as both Russia and the Eurozone are demonstrating at the moment (though in different ways), central banks are only as independent as politicians allow them to be, and only as credible as the governments that back them. If government can't be trusted to manage the money supply without causing inflation, then neither can a central bank - unless it is simply unable to create significant inflation.

But why are central banks so much less effective at creating inflation than governments? I think it is largely due to the way in which the money they create is distributed.

Government spending and taxation directly affects the behaviour of ordinary citizens. Ordinary citizens are by-and-large financially constrained: they have shortages of money relative to their desire for goods and services, and they have limited borrowing capacity. Therefore, if a government creates money and pays it to ordinary citizens, the likelihood is that a fair number of those will spend it. Equally, if government increases taxes - or people expect that it will - many people will cut their spending. True, people might not adjust their spending if they think that tax and spending changes are temporary: but then banks and investors might not adjust their behaviour either if they think monetary expansion or contraction is temporary. Ricardian equivalence applies as much to central bank operations as it does to taxation. 

Clearly, if government money-financed spending is likely to flow through directly into increased consumption by ordinary citizens, it can very easily lead to consumer price rises. Tax changes can be too slow and unwieldy to counteract this inflationary effect - and they are unpopular. The real problem with money financing of government is that politicians depend on voters for their jobs, and giving money away is far more popular with voters than removing it, even if removing it is in those voters' best interests. But the same could be said of central banks. Removing the punchbowl when the party is in full swing is equally unpopular whether the party is on Wall Street or Main Street.

Central bank monetary operations depend for their effectiveness on banks and investors being willing to adjust their behaviour. Unlike ordinary citizens, banks and investors do not generally suffer from shortages of money. Their behaviour is driven by their appetite for risk and their desire for return. Monetary policy operations aim to influence their portfolio choices by adjusting yields on certain classes of asset. The main effect of central banks' activities is therefore seen  therefore primarily in asset prices, rather than consumer prices. There may be some impact on consumer prices via interest rate effects, wealth effects and the famous "hot potato effect", but it will be much less than the impact of an equivalent fiscal stimulus. It is, frankly, inefficient. To be sure, a central bank supporting asset prices by means of large-scale purchases can interrupt a deflationary spiral: but then a government supporting house prices by means of guarantees and tax breaks can ward off a property market collapse, which might prevent a deflationary spiral forming in the first place.

Ambrose Evans-Pritchard argues that central banks can always generate inflation if they try hard enough, and cites Friedman's famous "helicopter drop" as evidence. But central bank helicopter drops are fiscal policy, since the money goes directly to ordinary citizens rather than to the financial system. Why not simply unchain the fiscal authority so it can do money-financed deficit spending, rather than getting the central bank to do it and calling it monetary policy? When the economy is in a slump, no-one is spending and no-one wants to take any risk, does it really matter whether the central bank or the government reflates the economy? Where did this absurd idea come from that the only good stimulus is a "monetary" one?

Rather than using the loaded terms "monetary" and "fiscal", we should talk about "indirect" and "direct" stimulus. Put like this, Krugman is once again clearly right - as, incidentally, is Friedman. Direct stimulus is obviously far more effective than indirect. How on earth could we possibly think otherwise?

Related reading:

Fiscal pessimism - Pieria
Some incomplete monetarist arithmetic - Pieria
Structural destruction - Coppola Comment


  1. The US and UK already operate exactly as you describe in your mythical scenario. When the Govt spends money, reserves are added to the non-Govt. This is exactly the same thing as printing money electronically. TSY issues securities as one option for maintaining a positive interest rate. If TSY didnt issue securities (QE) and the CB didnt pay interest on reserves, the Federal Funds rate would always be zero. In this way, issuing securities is already a monetary policy function. The Govt doesnt issue securities because it needs to get the reserves that only it can create, its simply a service the Govt offers the public. Krugman doesnt understand monetary operations so its no wonder he's confused.

  2. Said another way, both TSY securities and reserves are $ deposits at the Fed. Govt spending increases dollar deposits, taxation reduces dollar deposits. it doesnt make much of a difference if these deposits are in demand accounts (reserves) or term accounts (securities). Either way, its just an accounting entry at the Fed. nobody considers their bank account to have disappeared because they buy a 6-month CD, so what makes a 6-month T-bill any different?

    1. If we think of the Fed and the Government both inside one big black box, there is no difference to those outside between a CD earning interest and excess reserves earning interest. I think you too would like my model:

    2. Entries in Central Bank Reserves accounts are not usually created by governments. The central bank makes the creation of reserves available in line with the requirements of commercial bank clearing. It is more accurate to say that reserves are created by bank customers in concert with commercial banks.

    3. Central banks are Govt agencies so this statement is wrong:

      "Entries in Central Bank Reserves accounts are not usually created by governments."

      "The central bank makes the creation of reserves available in line with the requirements of commercial bank clearing."

      This is true

      "It is more accurate to say that reserves are created by bank customers in concert with commercial banks."

      No its not more accurate. They create reserves in response to Govt deficit spending also. All $17 Trillion in securities accounts were first reserves since you can only "buy" aka settle TSY securities with reserves. In other words, there is $17 trillion worth of US currency deposited into TSY securities accounts. And US currency can only be created by the Fed as a technical matter. They control the computer.

    4. Government deficit spending is funded by pre existing deposits ie selling bonds to the private sector and so does not inherently create reserves in itself.
      You say that only the government can create reserves so fundamentally your model puts the government as playing the central role of reserves and money creation in the money system but that is wrong as The Fed also creates reserves by buying corporate bonds , commercial bank bonds and recently other asset backed securities.

    5. Dinero, what you keep misunderstanding is that the reserves themselves can only come from the Govt. There is no entity that can create US reserves other than the Fed.

      The Fed does not buy corporate bonds so you are flat out wrong about that.

      All dollar deposits at the Fed come from the Govt. It doesnt much matter whether the dollar deposits are in demand accounts (reserves) or term accounts (securities). What is so hard to understand about this?

    6. Reserves are accounting entries on the liabilities side of the CB's balance sheet and there is a mixture of things on the assets side. The Government sells Bonds to the bond market in order to get deposits in its account for spending.

    7. The accounting does not lie. When the TSY spends or when the Fed lends $ deposits at the Fed increase. When TSY taxes, $ deposits decrease. Issuing securities does not change the amount of $ deposits at the Fed. It simply swaps reserve accounts for securities accounts. Which is no different functionally than transferring already existing funds from checking accounts to CDs.

    8. when the treasury spends, deposits at the Fed don't increase , they move from the Treasury's account to the account of a commercial bank.

    9. You are right on this one. My wording was poor. When the TSY spends, $ deposits held by the non-Govt increase. This is the definition of "printing money" which has of course been my point all along. When TSY issues T-securities, the $ deposits held by the Non-Govt do not change as they are simply swapped between different bank account types. Exactly the same process that occurs when you swap your checking account at Chase for a Chase CD. Again, this has been my point all along and is the reason why you have been incorrect all along.

    10. It is certainly not the definition of "printing money". That definition is a notion that you have contrived yourself in the process of incorrectly describing the the process that the Feds accounts adhere to.

    11. Adding money to the bank accounts of the public does not equal creating money for the non-Govt? You sir have reached a new level of revisionist reality.

    12. You have moved from "printing money " to "creating money for the non government". That doesn't fit either as the money already existed in the custody of the non government. Creating something is not the same as moving something.

      As you acknowledged - total deposits at the Fed are not created when the Tsy spends.
      Similarly When the Tsy receives taxes, total deposits are not decreased. Money moves from the bank accounts of tax payers, and the bank accounts of bond buyers, to the bank account of the Tsy then on again to the bank accounts of the recipients of government spending.

  3. I have a model where bond sales are sort of like a tax followed later by a stimulus check. So for a time they reduce the money supply. The above seems to agree with my model. Do you really agree with my model?

    1. No. You have the precedence wrong. Government spending precedes rather than follows bond issuance. Bond issuance sterilizes government spending. I explained this in some detail in the post, but you seem to have missed the point.

    2. "Bond issuance sterilizes government spending."

      Bit of a hoary old myth that. No more effective than offering deposit accounts.

      There is a liquid market in bonds. There has to be or few would hold them. Therefore you can always get the currency to settle accounts if you need to. Or you can just settle your accounts directly with the bonds - which would become increasing acceptable in a system artificially short of currency.

      As we can see with the emergence of bit coins, and loads of other fractional derivatives of all sorts of assets, settlement is done with lots of other things than pure state currency.

      Holding things in other forms doesn't stop spending. Unsurprisingly people choosing to save, for whatever reasons, stops spending, and if there are enough people saving out of income you probably don't need to tax.

      The level of saving you get is a bit of an 'animal spirits' thing - as the Japanese are constantly rediscovering.

    3. Other than that little quibble, a great post. Nice to see it explained from first principles.

    4. It does to some extent , on the effect it has on the demand and price for other financial assets, investments, commodities, land, and ways of allocating savings.

    5. Neil,

      Indeed, offering deposit accounts would be equally effective. The point is that to drain money, the population must be induced to save. Offering saving vehicles may be a sufficient inducement (it probably is in Japan). But if it is not, then government must resort to compulsion. Taxation is forced saving. So is a compulsory pension scheme, whether state- or employer-run.

  4. Sam Bowman does't understand that no net financial assets are added to the system by doing QE. Even if the bondholders are households, they don't have greater capacity to spend after this. Central banks are about price not quantity. Neither Krugman nor Koo understand monetary operations very well. Friedman's helicopter drops are an unrealistic dream. Central bank is not authorized to give people money, the government is. The helicopter drops are fiscal.

    "Clearly, if government money-financed spending is likely to flow through directly into increased consumption by ordinary citizens, it can very easily lead to consumer price rises."

    Yes, we call this demand pull inflation. Government spending without issuing bonds is no more inflationary than issuing bonds. One can argue about interest rates, that higher interest rates cause people to spend less. I don't know if that is true since government pays net interest rate to private sector, but this is unrelated to the question wheter issuing bonds with deficit spending is less inflationary. Fed can pay interest on excess reserves.

    "The real problem with money financing of government is that politicians depend on voters for their jobs, and giving money away is far more popular with voters than removing it, even if removing it is in those voters' best interests."

    I am really disappointed in Coppola by reading something like this. I am using Bill Mitchell's text to answer to this: „Apparently, it is good to have a central bank that can stand up to a government because the latter has a propensity to get drunk and the former has to take the “punchbowl” away.
    What the hell does that mean? Does it mean that we want a system where the democratically elected government operating within the legal framework of the nation and is pursuing a mandate can be stopped by an unelected and largely unaccountable set of officials in the central bank? Since when has that been an exemplar of progressive thought?
    My view of democracy is that we vote out governments who fail. We don’t want elites (corporate or central banking or otherwise) to exercise their own agendas. They were not elected. They are not accountable in the way we construct that term in political life.“

    1. Kristjan,

      Re your claim that independent central banks are not an example of “progressive thought”, that’s difficult to square with the fact that Scandinavian countries (who regard themselves as progressive) have independent central banks. Plus the Labour Party in Britain, which regards itself as progressive, made the Bank of England independent when Tony Blair first came to power.

      You’ll doubtless be disappointed to learn that about 99.9% of decisions taken by governments are not taken by democratically elected politicians: they’re taken by individual bureaucrats, and committees of scientists, economists and other suitably qualified specialists.

      Of course democratically elected politicians should have, and in practice do have the power to overrule any decision taken by the latter sort of committee. But most people, me included, are happy with technical decisions being taken in the first instance by technically qualified people, not politicians.

    2. "You’ll doubtless be disappointed to learn that about 99.9% of decisions taken by governments are not taken by democratically elected politicians"

      You are talking about EU? I think you are confusing decision making with expert advice.

    3. > Kristjan

      Good point about housholds capacity to spend but the ultimate purpose of QE is to get money to businesses and households where it will be spent rather than re-invested. So it is supposed to creates spending at some point. What I suspect a comment like that one from Sam Bowmen overlooks is that the purchased bonds still have to be re-paid so it is not printing liabilitie free pounds. Further to that- the government sells bonds to a market rather than borrowing from banks or the CB so that they don't create new deposits.

    4. Dinero, what you don't understand about QE is that QE gives businesses nothing that they didn't have before. If you have $million in treasuries are you waiting for the fed to do QE? You can't spend? You are able to spend any time you want to spend, you don't need QE in order to spend. Even in aggregate, the whole economy is not constrained because the dealers can borrow against treasuries. QE is pushing on a string. Businesses are not spending and investing because they don't see demand, not because fed hasn't done QE.

    5. Kristjan,

      "Apparently, it is good to have a central bank that can stand up to a government because the latter has a propensity to get drunk and the former has to take the “punchbowl” away."

      I said nothing about needing a central bank to "stand up to government". Quite the contrary, actually. Earlier in the post I wrote this:

      "Governments do not need central banks to control inflation. They can control it themselves."

      How much clearer could I possibly be that a credible government does not need to be disciplined by its central bank? I also pointed out further on that a government that is not credible nearly always lacks a credible central bank. The separation of central banks and governments is entirely illusory.

      Your misunderstanding appears to come from this line:

      "Removing the punchbowl when the party is in full swing is equally unpopular whether the party is on Wall Street or Main Street."

      Let me clarify. The central bank is responsible for removing Wall Street's punchbowl: the government is responsible for removing Main Street's.

    6. Kristjan

      I certainly do understand that. If a Merchant Banker swaps a £1000 000 Gilt for a £1000 000 deposit they are not going to be suddenly running down to the grocery shop to buy a cake or new a tool set for that matter. And I agree borrowing is demand led.

    7. sorry Coppola, my bad in that case, sometimes we think we read something that is not there really :)

  5. My fairly simple IS-LM take on this (which I reckon is a bit like Paul Krugman's) goes a bit like this:

    IS Curve: Y = C + I + G - T (downward sloping)
    LM Curve: MS = MD = f(Y,i) (upward sloping)

    Monetary policy interventions move the LM curve meaning it settles at a new equilibrium somewhere along the IS curve, lower i meaning higher Y as the IS curve slopes downward. Fiscal policy interventions directly push up Y, moving the IS curve to the right or left.

    Sam's rather extreme helicopter money example of eliminating tax and funding all government spending from newly minted money shifts the IS curve to the right as it reduces T from a value to 0, raising the value of Y, this is a fiscal effect, there would be an LM movement from raising the money supply too, but there is a clear fiscal effect.

    I think this is why most Keynesian types would view helicopter money as a fiscal and monetary intervention.

  6. I don't seem to recall good auld CH mentioning anything about a free banking system operation in tandem to a national dividend ( not national income) which would be modest in the west today given the destruction of physical capital these past 500 years..........
    Greenbacks would fill the purchasing power void but I don't think life would be very busy - people will work 15 hour weeks and be happy with enough


  8. “ It could do what central banks do, namely sell assets….Well, it could issue bonds”… If they issue a bond that is not selling an asset they already own that is called borrowing and it sits on the liability side of the government balance sheet.
    “Government bond issuance is monetary tightening”…. just wow!!
    “taxes are a means of forcing people to return money to government. They are, if you like, the equivalent of required reserves for banks”…. Required reserves are on liquidity banks hold, taxes are on income. Required reserves are not on banks’ returns the central banks does not force banks to post a percentage of their profit as Required reserves. How can bond issuance be compared to taxes? One is an income cashflow and one is on the liability side of the balance sheet. Taxes are not like interest rates charged by the CB, they closer to dividends
    “The real problem with money financing of government is that politicians depend on voters for their jobs, and giving money away is far more popular with voters than removing it, even if removing it is in those voters' best interests. But the same could be said of central banks. Removing the punchbowl when the party is in full swing is equally unpopular whether the party is on Wall Street or Main Street”…..except wall street does not elect central bankers and that is why central banks are meant to be independent

    The reason why government should not monetise its on debt by printing money is simply MORAL HAZARD and conflict of interest. The Central bank however could do it on their behalf mainly because the central bank will not do for its selfish reason like for example to run a large deficit to win votes and fund that deficit by printing money. In theory the central bank will do in the best interest of the economy for example to avoid DEFLATION. The central bank when they purchase government bonds they are not doing it to fund government spending they do it as a mean to increase the money supply and expand their balance sheet and they use government bonds because typically is the deepest market and carries less moral hazard ( you not favour corporate bond x vs y to fund one company vs the other). When moral hazard comes into question central banks quickly shy from govermnt bond buying QE… just look at Bundesbank latest views on sovereign QE. The moral hazard point is quite important! Governments could spend the money in places where it is not needed to just win vote, build extra schools, roads bigger hospitals may be in the shape of a coconut tree that can be seen from outer space; all redundant activities that could be dangerous for growth.
    “Governments do not need central banks to control inflation. They can control it themselves”. Yes they can but it will be the wrong inflation because it was no driven by higher structural aggregate demand but driven by virtual aggregate demand creating a virtual wealth which leads to hyperinflation eventually the collapse of the economy. Central banks can increase inflation

    1. I think you need to work through the accounting to see where I am coming from on this.

      Required reserves are in effect a drain on banks' profits: this is why raising reserve requirements may induce banks to charge higher interest rates on loans and/or pay lower interest rates on deposits. Regarding bonds, issuing a bond withdraws money from the private sector to the value of the bond, and replaces it with a future claim for the same nominal amount of money. That claim is a future liability of the government, but the economic effect is a money drain equivalent to a tax

      Central bankers are appointed by government. If government cannot be trusted, then neither can the central bankers it appoints. Your faith in central banks is touching, but supported neither by the evidence nor the logic.

      Sovereign bond-buying by central banks is fiscal policy, since it supports the price of government bonds, removing the market discipline that acts as a brake on government bond issuance. Please see my post "QE is fiscal policy" for a more detailed explanation.

      Hyperinflation is rejection of the currency, both now and in the future. It happens when neither the fiscal NOR the monetary authority is credible. It's interesting that you choose to ignore the considerable role of irresponsible central banks in hyperinflations - the Reichsbank in Weimar, for example.

    2. Your comment based on the Wong understanding of reserve requirements.Reserve requirements are the portion from the consumer deposit that banks are required to post with the central bank so it doesn't drain from banks profits it drains banks liquidity.

    3. No, I do not have a "wrong understanding" of reserve requirements. Reserves are remunerated at a rate not far above the interest rate on deposits, and the bank is additionally forced to pay a levy for deposit insurance. Therefore the effective earnings on required reserves are zero or less. The opportunity cost of having to maintain required reserves is a drain on profits.

    4. Finally, to think my comments are inferring a strong monocausality between credit creation and hyperinflation I think it is an undecorated mistake. One cannot dnie the relationship between credit growth and inflation however credit growth is not the only driver of inflation and the fact that during a period where the demand for credit slows because of an impaired sentiment does not refute the relationship between credit and inflation. I will not go into too much detail but I point you to a working paper by the ECB “EXCESS MONEY GROWTH AND INFLATION DYNAMICS”. Below is a brief summary

      “The existence of a positive relationship between money and prices is well acknowledged in the economic literature. A large consensus can be found on both the direction and the dimension of the effect of an increase in the monetary aggregate on prices developments. The statement that in equilibrium monetary policy is neutral hinges on the quantity equation which in turn defines a positive “one-to-one” relationship between monetary and price growth over a long-term horizon. The theoretical consensus on money neutrality is also supported by well documented empirical evidence, in both time-series and cross-countries analysis. The economic profession, however, highlights that, since money is not the sole cause of price developments in the short run and that a certain period of time must elapse before the “one-to-one” relation emerges, the neutrality may not to hold over shorter horizons”

  9. “So why is money financing of government feared? It is feared precisely because it is far more likely to be inflationary than money creation by an independent central bank. Krugman is right. Central banks simply are not as effective at creating inflation as governments”… it is hard to state as fact something that happened empirically few times. Just because central banks failed to fuel inflation in the most recent episode it does not mean they can not. It is situation dependent. I am sure if CBs were easing and QE when banks’ balance sheet was very healthy then the result would have been rapid credit extension and inflation. However we just had a banking crisis and banks’ balance sheet is impaired and hence when the CB eases monetary policy we ended up with a liquidity trap as banks were not healthy to lend in fact they needed to de risk and deleverage; and money got stuck in the system as the leverage moved from the banks/consumer balance sheet to the government and central banks’ balance sheet (government balance sheet via fiscal easing and CB’s balance sheet via funding this fiscal loosening).

    “if a government creates money and pays it to ordinary citizens, the likelihood is that a fair number of those will spend it”… but is that what they do/did… last time I checked governments borrowed/created money and spent massive amount of tax payers’ money on bailing out the banks and did not spend it paying ordinary citizens!!!??

    The issue is not the CB the issue is the liquidity trap. If the easy money that the central bank is given to the banks is reaching consumers and MTEs then they will spend more and investment more. They can buy houses which will go up in prices, from which then they can extract equity to pay for new investments of just expensive shows which would lead to more economical activities and healthy inflation until money because too cheap and things which are not needed end up been bought or invested in and that is when inflation because bad and CB cut the supply of cheap money. Now that is the idea but in this case we have the liquidity trap as banks try and regain the virtual wealth they lost in the crisis (I say virtual because that wealth was built on leverage rather than on real growth)… you want inflation do not get the government to pay people more money for nothing, just ease credit criteria get the banks to lend without having to hold huge amount of capital against the risky assets they generate from their lending activities and you will get inflation my friend

    1. Your comment is based on a wrong understanding of the relationship between the monetary base, credit creation and inflation. Increasing the monetary base does not automatically result in increased bank lending. Increased bank lending does not automatically result in higher consumer price inflation. There was huge credit creation in the years before the 2008 crisis despite a historically normal monetary base/bank credit multiplier relationship. CPI during this period was low and stable. It is simply incorrect to assets a simple causal relationship between the ability of the banks to create credit and the willingness of the private sector to borrow. Prior to 2008, the private sector was very willing to borrow, largely because of rising asset prices (not CPI). Now, the private sector is unwilling to borrow: even healthy banks are reporting a shortage of creditworthy borrowers. Where credit is concerned, supply does not necessarily create demand. You should read Richard Koo on this subject - I cited him for a reason.

    2. Firstly, please forgive the spelling mistakes in my text. Now the relationship between RR and banks profit is positive but for sure is not first order onto function and at best there is a weak causality there. i.e RR results in an opportunity cost and higher RR does slow banks lending activities and that is why RR is used as monetary policy tool. However, RR is not linked to profits, and banks do not have to post higher RR the more profits they make. Hence it is a fallacy to compare RR which is a liquidity buffer that banks post with CB and get back eventually to give back to depositors, to taxes which are performance related and are given to governments not to be returned. Based on your comparison stricter credit conditions and Basel III is also tax on the banks!!! I do get the logic but I think it is misleading to think RR vs taxes are equivocal. More importantly you are yet to address my point that it is not the failure of the central bank via QE to generate healthy inflation it is more the fact that the impaired banks/ consumer balance sheet and stricter credit criteria that resulted in a liquidity trap which contributed to muted inflation (I say contributed because it is not the only factor, other factors included damaged consumer and investor sentiment post 2008. Folks would rather save then spend as they fear they still might lose their job and hence might need that white penny for such gloomy day). I do understand your logic, however I just think it is dangerous to state as a fact a result/solution that is not closed form but merely a few empirical data points.

    3. Regarding the Reichsbank in Weimar, I do not recall saying that CB do not play a role in hyperinflation to the counter my comments were focusing on the important role, which you seem to dismiss, the CB plays in generating inflation in all its forms, hyperinflation, disifnaltion and deflation. I will not go into much details of the German experience of hyper inflation 100 years ago but if you have not read it I recommend Dying of Money by J Parsson. The idea that CB cannot generate consumer inflation and only asset price inflation is misleading. The fed during the greenspan years did generate healthy inflation during the Clinton’s “The National Homeownership Strategy: Partners in the American Dream”. The fed kept rates low and encouraged mortgage lending and as house prices went up folks extracted equity to spend that money on products, services and new investments. The result was domestic demand driven growth and healthy inflation. However it also did lead to the housing bubble. The point is, it is not just the CB and its monetary actions that could influence inflation but also the transmission mechanism of those monetary actions to the rest of the economy that is probably the most important factor. In the Greenspan years the easy monetary policy (cash that you recommending the government to just hand out to consumer) was transmitted to consumers via the housing markets

  10. Credit banking in the modern economy is the main driver for inflation (costs) through capital goods overproduction.
    The costs of this overproduction is socialized as human consumption declines.
    Any casual look at my cities labour dynamics will prove this.
    Pre euro modernism male manual labour effectively worked for pints and not loads of money porches.
    Guys worked so as to have the tokens to bullshit afterwards.....
    This idea that we all will become materialistic bastards is absurd.

    Its a simple result of the front loading of production / advertising of credit centric goods production.

  11. The difficulty can be seen in my city today.
    There is a programme to clean out empty council houses....
    But the cleaning alone may cost up to 7,000 Euros a house before even the repair men come in , a house occupied by a hoarder can be much more expensive.
    All of this is dirty manual labour.
    I have done this myself but only for cash , at the moment the policy is becoming more official which means more migrant labour minimum wage labour.
    Which means almost nothing will be spent locally.

    Its really cheaper to waste resources building a new house but at the cost of a further subtraction of local purchasing power.
    There is simply not enough tokens in the city.
    You get calls from the local neo liberal minister that the city must get into debt to overbuild water scarcity structures when you have a whole army of men willing to do local city corporation work if given enough tokens..........
    Raising global capital to dig a hole in the ground is the last straw for many Irishmen , at last they have woken up..........


  13. The deep political and social flux ambitions of central bankers are explored by Richard Werner using the above jap example.
    The lesson : central bankers are black bastards - never to be trusted.
    (The imagery of vipers is used throughout )

    Inflation or deflation matters little to people - it is their real daily purchasing power and spiritual happiness.

    1. Werner is making himself rich by peddling conspiracy theories to the unsuspecting. He makes assertions for which he provides no evidence, and when you ask him for evidence he tells you to "buy his book", which is £30 in the paperback edition and £85 hardback (and currently out of stock on Amazon). If he is really interested in dishing the dirt on central banks, he should disclose his evidence freely.

      Furthermore, he makes serious errors. I am no fan of the behaviour of some central banks, but at least I know some monetary economics. From the conversation I had with him recently, he appears to know very little about how central banks actually conduct monetary policy, or even what their mandates are. For example, he said that interest rates couldn't be a main ECB policy tool because they appear to lag, rather than lead, GDP: but the ECB targets price stability, not GDP. When I challenged him on his errors he resorted to ridicule.

      His Quantity Theory of Credit is in my view seriously flawed, since it ignores wealth effects and multiplier effects. I pointed this out to him and gave him a realistic example of multiplier effects from house purchase, but he was simply not interested.

      In short, I can't take him seriously, I'm afraid, apart from his work on endogenous money - and even that is less thorough than the work of Admati & Hellwig, for whom I have considerable respect (I have met both).

  14. Sorry Frances but practical on the ground experience has thought me so much in the post 1995 period.
    Ireland is a bit like a Iceland within the eurozone.
    It is so instructive.
    Mt gut therefore tells me Werner is close to something.
    These bank scarcity memes are absurd and have reached new levels of absurdity with the water thingy....
    The local managers simply don't have the imagination for this '" structural reform"
    Something very strange happened in this non place - reaching its apex in 2009 when the big bank came up from the bowels of hell to 'advise de guberment'

    Being a recent convert to social credit theory I myself do not buy all of what he is selling but I find the story of post war Japans political dynamics very creditable.
    That is what I took away from his piece.
    Not the nuances of his take on capitalism.

    Everything I witness today stinks of centralism .
    For example
    The Irish CBS attack on the credit union system is classic banker tactics.

  15. I'm sorry. I profoundly disagree with this post. Money is required, not because people have 'relative poverty' but because people want to indirectly exchange their goods and services.
    Money, in short, is a medium of exchange and not a source of wealth. Like Adam Smith pointed out, true wealth is abundance of goods and services not abundance of money.
    Lastly, on the issue of relative poverty, I know one can argue that specialization is what perhaps can be characterized as relative poverty but it would be wrong to do that. Specialization enhances productivity and as a result creates abundance. This creation of value is what necessitates money, a good that can store value, for purposes of exchange with other goods and services in future. The notion of 'relative poverty' seems to assist the ignorance by stealth the notion that it is productivity that creates the ability to buy.


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