Some Basic Macro and Monetary Econ

My mind has been a tempest of monetary economics lately; I can't figure out why my views aren't consensus, despite being built on basic theory. Many economists have a rigidly old Keynesian view that monetary policy, and QE in particular, is all about interest rates (it isn’t), that it is ineffective once rates are down to 0 (it isn’t), and that QE is only about reducing longer term interest rates (it isn’t, and downward pressure on longer term interest rates is merely a second order effect that is very weak at best).

So here’s what should have and can still be done to prevent current unnecessarily tight monetary policy from dragging down growth. Central banks can follow the example of Sweden, and put a negative interest rate on excess reserves[1], to force that money out into the economy. Because, as has been understood since John Locke, money locked in a vault is the same as if it had been burned, it effectively doesn't exist. Right now the Fed pays banks for keeping money with the Fed, the result is that money is pulled out of the economy to earn a no-risk return for doing nothing, rather than be invested. Doing so would make policies like QE more effective, thus needing less of it.

But wouldn't this cause inflation? Let’s hope so. Nominal GDP growth (which is real GDP growth and inflation) is too low[2]. Higher NGDP growth in a recession, and its recovery, means faster labor market recovery, lower real debt burdens, and higher investment as the real return on sitting on piles of cash falls. And if the inflation part gets too high? Great, now the Fed can go back to normal and increase interest rates to keep it from going too high. That’s exactly what we want, no more zero lower bound. That will help savers who currently get 0.1ish% on their savings and lose in real terms given that inflation is above 0.1%.

What if that doesn’t work? It may surprise you, and in fact probably surprise most economists, that there are "fool-proof" methods for escaping the zero lower bound. The best is printing money to buy foreign bonds and assets, thus driving down the exchange rate. With fiat money, there is literally no limit to how far down a central bank can push the exchange rate[3]. This will necessarily create domestic inflation, thus NGDP growth, as each individual dollar loses purchasing power on the world market. In fact any successful monetary stimulus would cause exchange rate depreciation and higher domestic inflation, even the old Keynesian lower long term interest rates junk.

But isn’t that a ~beggar thy neighbor policy~? No, and if you’re an economist and thought that find a new field to suck at. Economics is not a zero sum game. The faster recovery caused by these policies would mean a richer country for whoever does them. While exports would be cheaper, a richer country will consume more goods, and no country makes all the goods it consumes by itself. That means more imports and more global demand[4]. 

What if everyone does it? Does the world just stand still? No, it would mean a worldwide expansion of the money supply, which will increase worldwide NGDP and lead to the benefits mentioned above. This occurred in the Great Depression: as the monetary strait-jacket of the gold standard dragged the world economy down, country after country abandoned it, and their currencies immediately depreciated. In each country recovery set in shortly after, with numerous countries experiencing currency depreciation at the same time.

Aren't I just asking for run-away inflation? No, inflation depends on the money supply, if you double the money supply permanently, the price level will double in the long run; in the short run interest rates fall. Inflation never “runs away”, or becomes detached from monetary expansion. In normal times I’m as much for keeping inflation relatively low and stable as anyone else. And one reason to want higher inflation now is so that central bank interest rates can go above zero and once again be used to stabilize the economy rather than these unconventional policies. In good times too much inflation is usually the problem, in these times it’s too little. What I’m for is the optimal amount.

Please please ask me about any of this if you don't understand or are skeptical, and I'll be able to answer. There's a lot of foundation that I didn't want to spend pages and pages building from scratch.







1. By which I mean reserves in excess of the legally required reserves

2. Many of these benefits come from just the inflation part, inflation speeds up labor market recovery because prices and wages are nominally sticky in the short run (meaning their nominal prices are harder to adjust). Inflation reduces debt, which is denominated in nominal terms. Why focus on NGPD? Because it captures these elements plus the effects of changes in real GDP. Therefore, NGDP is the best indicator at capturing both sides of things, the nominal (which can have real effects) and the real. NGDP is also a better indicator for monetary policy for the same reason. Imagine a country with 0% GDP growth and 2% inflation and a country with 4% GDP growth and 2% inflation. A central bank with a 2% inflation target (like the Fed) would be indifferent. A central bank with a 5% NGDP target, for example, would loosen policy to stimulate the economy in the former case and tighten policy to moderate a boom in the latter case.

3. Switzerland has done this to keep the Swiss Franc from appreciating against the Euro, which would be harmful to the Swiss economy. Sweden has recently hinted it may do the same if conditions don’t improve. The US depreciated its currency in the Great Depression, and the economy started to recover almost immediately. France devalued its currency after WWI to help its economy recover. This is all old news.

4. In economics this is the familiar substitution vs income effects. Cheaper exports will cause consumers to substitute the cheaper products for more expensive ones. The increase in real incomes will cause higher consumption in general. The effects pull in opposite directions. The net effect depends on the relative strength of the two forces. Substitution effect leads to more exports, income effect leads to more domestic consumption/imports. In the case of the US in 1933, when exchange rate depreciation was successful, the trade balance worsened as net exports declined. The same occurred shortly after Japan recently renewed its monetary stimulus efforts.