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The 2007-9 recession has induced governments to expand borrowing to finance additional spending. It is widely mooted that even this will not be enough and that governments may have to resort to printing money to boost demand even further.

Money printing has got a bad name for itself and it is obvious that excessive printing is inflationary. On the other hand printing the right amount can be entirely beneficial: the only effect, ideally, would be to raise demand by enough to bring employment levels back up to the level that obtained a year or two ago, with little inflationary effect.

In short, money printing is not necessarily inflationary. David Hume, writing in 1752, recognised this in his essay “Of Money”. He said in reference to an increased money supply “If the coin be locked up in chests, it is the same thing with regard to prices as if it were annihilated”. In other words the effect of an increased money supply depends on what people do with it: if they don’t do much, there wont be much of an effect – on inflation or anything else.
The UK money supply (M4) expanded by a factor of 2.6 in real terms between 1982 and 1998. Yet inflation was subdued for five years before and after 1998. (Source: Richard Lipsey’s famous text book).

As to whether governments have the skills to print exactly the right amount of money to deal with recessions is debatable. Milton Friedman claimed governments do not have this skill, and that governments should expand the money supply by a small amount each year, with booms and recessions being left to work themselves out. Certainly Friedman is supported by the money supply figures for the UK over the last 15 years or so. That is the money supply expanded by about the recommended "Friedman" rate up to 2004. Then in 2005, 6 and 7 the rate of expansion doubled. We are now living with the consequences (not that the UK would have totally escaped the credit crunch anyway).

So what now? I think it is too pessimistic to say (a la Friedman) that government is too incompetent to do anything. I think there is a 60% chance government can intervene and improve matters. But Milton Friedman (and the German Finance Minister Peer Steinbrueck, who has similarly conservative views) could be right.


Quantitative easing.

Money printing can be done with a view to quantitative easing. Q.E. consists of government buying up securities, mainly long term government securities.

QE has little effect on inflation. One reason is that securities are regarded by their owners as SAVINGS. And savings are by definition portions of savers’ wealth that they do not intend spending. Thus when some government induces a saver to convert their securities to cash, the cash is unlikely to be spent. “The coin will be locked up in chests”. Hence there will be little effect on demand or inflation.

QE seems fair enough where it consists of buying banks’ poisonous assets with a view to preventing a catastrophic or systemic banking collapse. Beyond that, it is a debatable policy in the present circumstances. One objective of Q.E. is to lower interest rates, but the latter encourages borrowing, and isn’t it excessive borrowing that got us into trouble?

The second purpose of money printing (as intimated in the first para above) is simply to raise demand, where it seems that government cannot borrow any more. Indeed the whole business of borrowing and spending with a view to boosting demand is a bit questionable. Borrowing is deflationary, while spending is reflationary. If the object of the exercise is to reflate, why borrow?

Obviously if a government prints money INSTEAD OF borrowing and spending, the total amount spent would need to be less than would be the case in the “borrow and spend” scenario (for a given reflationary effect).


The aftermath of money printing:

Whether a government goes for the “borrow and spend plus print” option or the “spend and print” option, the effect is to expand the monetary base or “high powered money”. The monetary base is the base on which banks build their pyramid of credit. And in a year or two, the incompetents who run banks will be thrilled to have an expanded base on which to build their credit pyramid. Clearly governments need to be ready to clamp down on this activity with deflationary measures of some sort. Or in the words of William McChesney Martin, former chairman of the Fed, central banks should “take away the punch bowl just when the party gets started”.

Deflationary possibility No 1: reverse the money printing operation, i.e. have government collect more in tax than it spends. This amounts to destroying money.

Deflationary possibility No 2: Curtail the fractional reserve system. The fractional reserve system effectively allows private banks to print money. If the F.R. system were curtailed a larger monetary base would be needed, but it would be a more stable system, would it not? Private banks exploit their “money printing” powers in a pro-cyclical manner. So curb their right to print money, one gets a more stable system. Also it is questionable as to why seigneurage, i.e. the right to print money, is in private hands. A country’s currency is a national asset. Thus it is arguable that the nation has a right to print more of its money, if it chooses, not private institutions.

There are a number of advocates of this policy, e.g. see William Hummel in
particular the section at the end entitled “Plan for monetary reform”.

See also The Money Reform Party This site has a good selection of thought provoking quotes from famous historical figures on the subject of money, e.g. Marx, Abraham Lincoln, etc.


Deflationary possibilities Nos 3,4, etc:

Ban 100% mortgages. Willem Buiter has suggested limiting mortgages to 80% -

Another old trick: have the central bank demand special deposits from commercial banks – possibly non interest bearing.

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