Friday, 30 September 2011

A new name for an old game

This is Part 2 of a two-part post reviewing Finance for the Future's paper proposing so-called "Green Quantitative Easing (QE)".

PART 1 of the post, "A Doomed Assessment", reviews Finance for the Future's assessment of the Bank of England's Quantitative Easing programme in 2009-10.

PART 2 reviews Finance for the Future's proposal for government investment in the economy specifically to further green objectives as outlined in the New Economics Foundation (NEF)'s Green New Deal. I would like to make it clear that, as I am neither an economist nor an environmentalist, I am not concerned with the merits of the Green objectives themselves. I am merely commenting on the financing proposal. For a discussion of the Green objectives and their potential economic impact, I'd suggest you read Simon Cooke's blog.

BACKGROUND AND SUMMARY OF PART 1

Part 1 of this post can be found by following the link above. I admit it is pretty wonkish and therefore hard going, so if you want to skip the gory details, my conclusion is as follows:

"The authors' assessment of QE was doomed from the start because of their abject failure to understand what QE is and how it works. In particular, their confusion of central bank and government, and their evident lack of knowledge of the mechanics of fractional reserve banking, mean that this is a very seriously flawed analysis."

PART 2 - "Green" Quantitative Easing

The stated aims of "Green" QE, according to the authors, are as follows:

1. To provide the boost to the rest of the economy that the banks and financial services sector received from the first round of quantitative easing;

2. To finance a Green New Deal;

3. To promote new investment in productive capacity in the UK economy;

4. To refinance existing government related loans at low cost, so freeing public sector organisations and agencies to undertake new economic activity.

It is immediately apparent that these are much more diverse and wide-ranging aims than the stated aims of QE, and at least two are fiscal, not monetary, objectives. QE is a monetary policy tool used to substitute for interest rate policy when interest rates are close to zero. It is arguably not a suitable vehicle for delivering fiscal policy. These objectives are also, I would suggest, impossible to achieve through central bank money creation without compromising the independence of the BoE. Independence of the central bank carries a significant advantage in that monetary policy is not subject to political interference. Do we wish to return to a state-controlled central bank? Do we want the central bank involved in fiscal matters?

However, reading on it is quickly apparent that the authors are not talking about QE at all:

"In each and every case we are suggesting that the government spends the funds made available to the next likely round of quantitative easing to feed directly into the economy, and does not do so through the existing commercial, High Street and investment banks..." (my emphasis)

Now, in Part 1 I pointed out that government does not provide funds to the BoE for QE - the BoE creates the money out of thin air. If the government provides funds - presumably in the form of new government debt - then it is not QE. It's good old-fashioned direct investment by government. Calling it QE is just giving a new name to a very old game.

I looked through Part 2 of this paper to see if I could find any indication that the authors had any intention of funding their objectives with newly-created money by the central bank. If they had, then they could perhaps argue that QE is an appropriate descriptor. But I could find no reference anywhere to creating money to fund these activities. In fact throughout Part 2 there is repeated reference to public expenditure and borrowing, neither of which have anything to do with central bank money creation. On page 12, for example:

"Undertaking these activities would give the economy an immediate shot in the arm as well as providing infrastructure of lasting use which would more than repay any debt incurred in the course of its creation..."

"...We stress, what we propose is borrowing for investment, not borrowing for current spending. We are not alone in arguing this..."

"This is what we believe the programme we recommend would do and this is precisely why it is approapate to do it now when the cost of government borrowing is so low, a point Wolf and Skidelsky also make. This borrowing now to spend into the economy is the basis for the first stage of Green QE2 - and of the Green New Deal"

And on page 13:

"We recommend Green QE2 be used to deliver the funds that are needed for local authorities to draw on to take that risk. It should also provide the local capital that is needed to ensure the private sector joins them in delivering local green solutions. This will help create the employment we so badly need and in the process generate long term savings for the UK that will more than pay the cost of this debt...."

"That same low cost of borrowing does, however, bring us to the final issue we believe Green QE should address...."

Now, I'm not arguing that direct government investment in the economy is a bad thing. As I said at the start, in this post I am only commenting on the financing approach, not on the merits of the Green proposals. If a future government wishes to issue lots more debt to finance the aims of the Green New Deal, it can propose that to the electorate and obtain a democratic mandate to do so. But it should be called by its name - debt-financed government investment. It is emphatically not Quantitative Easing - of any colour.

And one final comment. I admit that I am really rather relieved that the authors have comprehensively misunderstood what QE is. If they had really been proposing creation of new money by the central bank to finance public works, I would be planning to emigrate. I don't want to live in Britain's version of the Weimar Republic. I know that various economists have suggested that government, not banks, should have control of the money supply. But I am by no means sanguine about that. Expansion of the money supply to fund spending into the economy is known to be inflationary. Sometimes that's a good thing, and yes, it's true that investment shouldn't be inflationary. But would politicians exercise sufficient caution in the use of such a powerful tool? I doubt it.

1 comment:

  1. I think you're quite safe to remain in good old blighty either way Frances.

    Nobody takes Murphy seriously

    ReplyDelete