Monetary and fiscal stimulus

A Scotsman leader expresses concern about the Bank of England's announcement yesterday of a further £50 billion programme of quantitative easing, and notes that all other stimulus options are exhausted.

This is not correct. All stimulus options have not been exhausted.

The latest National Institute Economic Review from the National Institute for Economic and Social Research (NIESR) suggests that in the current conjuncture there is still scope for a further fiscal stimulus. Jonathan Portes, NIESR's Director writes

The UK economy currently suffers from deficient demand; the current stance of fiscal policy is contributing to this deficiency. A temporary easing of fiscal policy in the near term would boost the economy. The credible commitment to a sustainable fiscal policy over the longer term provides the Government with the flexibility to provide a clearly defined and temporary boost to near-term demand. An increase in government investment would not have a significant impact either on long-run sustainability or – given the way they are defined – the likelihood of the Government meeting its fiscal targets.

In any event, there are concerns that quantitative easing has only limited impact on the growth of real and nominal GDP. Bank of England estimates suggest that the initial £200 billion of quantitative easing may have only raised GDP by a once and for all 1.5%. A respected commentator such as Chris Dillow suggests that this is likely to be an overestimate. I agree with him. This is what one would expect anyway if interest rates are at the lower bound and we are technically in a liquidity trap. To simplify, sellers of bonds to the Bank may simply be sitting on the cash, with banks reluctant to lend. The ripple effect of re-purchases of other financial assets pushing up their prices and the downward effect on sterling is likely to have been relatively weak. It is clear that while base (narrow) money has expanded due to QE, broad money (M4) has not expanded by much, confirming the absence of much greater lending and the creation of bank deposits on the back of QE. See this chart

In these circumstances, when the transmission mechanism of QE through to the real economy is weak and there are concerns about the further borrowing required to fund a further fiscal stimulus, the solution is to combine the two. That is finance the further fiscal stimulus by printing money.

The leading macro-economist Brad DeLong of the University of California, Berkeley, notes

By contrast, the alternative expansionary policy is for the government to print money and spend it buying useful things. Then:

1. The buying of useful things raises spending.
2. Financing it by printing money rather than issuing bonds means no increase in interest rates to crowd out private spending.
3. Financing it by printing money rather than promising to levy future taxes means no increase in the present value of future tax liability to crowd out private spending.
4. Financing it by printing money means no worries about any increase in fears of some future government default........

To try to target nominal GDP using either only monetary policy or only fiscal policy seems hazardous. To coordinate--monetary and fiscal expansion, money printing-financed purchase of useful things--seems to be the winner.