Money is not everything

Money is not everything to increase inflation.

Money is not everything, not the money supply, anyway. I recently wrote that I have a hard time understanding why everyone thinks that raising money supply (all cash and savings) can raise inflation or end deflation. I once thought it too, but my appearance came in 1998 not on the road to Damascus but on the way to Tokyo.

At that time, I also thought that the Bank of Japan could end deflation if it were to try it out. I was sure that if you doubled the monetary base (commercial bank stocks plus all the money in the country) it would always be able to raise prices even if lending rates were already at zero. So I tried to prove it by constructing a minimalist Keynesian model.

To my surprise, according to the model, the size of the money supply is irrelevant when the borrowing rates are close to zero. You might think that it is almost self-evident that doubling the money supply will eventually end up doubling the price level. In fact, the model suggests that in order to double the prices, the current money supply and all future must double.

If short-term borrowing rates are close to zero, changing the current money supply without change and future – and consequently future inflation expectations – is irrelevant. As a result, the impact of monetary policy is not at all obvious. Central bankers can change the monetary base today, but can they commit that they will not reverse the expansion when inflation finally increases?

It is not at all obvious and it is certainly much more difficult to “promise reliably that they will behave irresponsibly”, ie not to limit the expansion of money supply when inflation is rising in the future, rather than react when the economy is in recession.

Evan Pritchard (Daily Telegraph columnist) wonders what will happen if the central bank just gives money to households. He notes that this would be a fiscal policy, it would be essentially a giant transfer program and not a monetary policy firm. One can say that no matter how we call it, but the difference is not just academic: Central banks do not give money.

What they are always doing is some sort of asset exchange in which they buy assets or give out loans that are then made assets. I am sure that neither the American Federal Bank (Fed) nor the Bank of England (BoE) have the right to simply give money in exchange for the right to lend. If I’m wrong about that, then charge $ 10 million.

Is everything just a theory? No. Huge increases in the monetary base that we attempted in previous episodes where we had a liquidity trap had no noticeable effect. We now have the experience after 2008, which is certainly not an example of how the central bankers have easily coped with economic recessions. To be clear, I have supported quantitative easing (money laundering or increasing money supply through the massive bond and loan market from central banks) and in the UK and the US for the following reasons:

First, if buying long-term and more risk assets can help and can not hurt.

Secondly, given the political paralysis in the US and the misguided dominance of macroeconomics in Britain, quantitative easing was the only thing we had. However, the view that, until 1998, central bankers can always inflate as long as they want it, it simply is not verified either theoretically or empirically.


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