Overt money financing for AlbaniaALTax
The basic reason why the recovery from the last years decrease of economic growth and the recovery of economy in these years has been so slow and difficult, is shown to public debt and performing loans that are in the worst position of historic values in the last two decades.
That rising leverage, focused on working without money and corrupted privatization processes, left many companies and individuals severely overleveraged when
confidence broke and the credit rate from banks fell. That then unleashed a wave of attempted private sector deleveraging which depressed nominal demand and drove economies into bad positions. And that in turn created an environment in which debt does not actually go away but simply shifts from private to public sector:
- With large public deficits the inevitable consequence of recession and slow growth, and indeed necessary to sustain growth
- But with the resulting increase in public sector debt as percent of GDP seeming in turn to require public debt consolidation and austerity
- Austerity however, which in turn has a depressing economic effect
That is I believe the essence of what has occurred: and it is a pattern which should have been familiar from the Japanese experience after 1990, well documented by Richard Koo in his book The Holy Grail of macro economics. And it is the pattern which has been succeeded in Albania. So too much private debt to banks, too high a level of leverage, and post crisis debt overhang can play havoc the macro economy.
What about financial sector, and especially what about banks?
Banks in this years do not just take pre-existing money and lent it on: they created credit (bank assets) and matched money or other bank liabilities, which did not previously exist: and by maturity transformation (with loans of longer maturity than their deposits) they created new purchasing power in the economy. Obviously if they create too much purchasing power they might produce harmfully high inflation. But in the years running up, we had low and stable inflation, so that seemed to justify the assumption that whatever the level of leverage in the economy, it must be broadly optimal. And that in turn might have been a reasonable assumption if all credit was indeed extended for the purpose which undergraduate textbooks assume to fund new capital investment.
In this financial and economic environment should we accept the second half 20th-century economist’s idea that governments and central banks together should, when the conditions are appropriate, use money financed fiscal deficits as a means to stimulate consumption and push the economic recovery?
There are no reasons which make overt money finance (OMF) unfeasible, no reasons why it must lead to excessive inflation, and there undoubtedly exist circumstances in which it would be the optimal policy. The technical feasibility of OMF, and the fact that it need not lead to excessive inflation, is most easily understood if we think in terms of a world without fractional reserve banks, in which all money is either paper money or electronic money held at 100% reserve banks, and in which therefore the increase in the money supply is precisely determined by the quantity of new money which the central bank and government together create.
If the central bank and government together arrange monetary finance of a small fiscal deficit (say 1% of GDP), a relatively slow growth of aggregate nominal demand will result: but if they finance with money a much larger fiscal deficit, a far more rapid growth in aggregate nominal demand will result and in all likelihood excessive inflation.
The QE programs of the Federal Reserve, the Bank of England, the Bank of Japan and the ECB were all justified on the grounds that nominal demand was insufficient to achieve inflation targets: and the alternative arguments for still larger debt financed fiscal deficits, put forward by for instance Paul Krugman or Larry Summers, were likewise predicated on a belief that aggregate nominal demand was deficient.
Moreover, and again from a purely technical point of view, there are strong arguments that in some circumstances OMF could be superior to the other two options, because more likely to be effective and/or less dangerous:
- Compared with debt financed fiscal deficits, OMF may be more effective because it does not leave us struggling with the question of what to do about future public debt burdens, nor create the danger that the anticipation of those future debt burdens will induce a Ricardian equivalent offset to nominal demand stimulus today
- And compared to ultra-loose monetary policy and QE, it may be both more effective and less risky.
- More effective because the transmission mechanism is more direct, injecting new demand, as Friedman put it, directly into the current income stream, rather than relying on the indirect transmission mechanisms of QE, by which higher asset prices are meant to induce increased investment or consumption by wealthier companies or individuals.
- And less risky because the sustained ultralow interest rates to which a purely monetary policy commits us, may well produce dangerous financial engineering operations long before they stimulate the real economy, and because ultra-loose monetary policy can only ultimately work by re-stimulating the very growth of private credit which first got us into this mess in the first place.