The Fed must print money to head off a global crash

By Adam Posen
August 31, 2011

By Adam Posen
The opinions expressed are his own

It is past time for monetary policy to be doing more to support recovery. The Jackson Hole conference has come and gone, and no shortage of excuses was provided for central banks to hold their fire — even though most economists acknowledged the grim outlook for the advanced economies.

Too much attention has been paid, however, to the failings of fiscal policies and to the shortfall from effects of earlier quantitative easing. Further asset purchases by the G7 central banks are needed to check not just a downturn, but the lasting erosion of productive capacity and of debt sustainability — especially when even justified fiscal and financial consolidation is undercutting short-term recovery. Easier monetary policy will increase the odds of other policies improving, and those policies’ effectiveness when they do.

It is also past time to stop fearing inflationary ghosts. There is no credible threat of sustained higher inflation in the advanced economies that should restrain central bank action. The rate of wage growth is tepid and compatible with price stability, at most, even in Germany; the inability of wages to keep up with recent real price shocks underscores the ongoing downward pressure from labour market slack. Consumption was driven down by fiscal tightening and household retrenchment as much as oil prices, and those forces will be ongoing. Had consumer confidence not been weakly footed to begin with, the oil shock would not have had such an impact.

Commodity prices have since demonstrated again that they go down as well as up, and thus monetary policy should not react to their short-term gyrations (and deceleration in Western growth will likely send them further downwards). Credit and broad money aggregates are barely growing and current account deficits are slowly shrinking, so no asset price bubbles will emerge. Importantly, interest rates on long-term G7 government bonds display no consistent rise in inflation expectations, no matter how the data is parsed.

Some of us had seen this coming. This is what happens to economies following a financial crisis, particularly when the crisis hits simultaneously across integrated markets. That is why I began advocating more quantitative easing in the UK a year ago. Yet even if some believe that the recent setbacks reflect new developments — rather than just long-run vulnerabilities (fragile Central European banking systems, dysfunctional American fiscal politics, British over-dependence on the financial sector) exposed by the crisis — that still should be enough to downgrade any plausible prior forecast for growth and inflation to where additional monetary stimulus is called for on its own terms.

Just because a downturn is expected does not mean its course is inevitable, and some of the present prospects’ severity certainly still can be usefully offset. The lesson from past post-crisis recoveries, whether from the late 1930s worldwide, the late 1990s in East Asia, or the 2000s in Japan is that aggressive monetary easing can ease the process of real adjustment and limit its lasting damage to economies and to people. Insufficient monetary stimulus, let alone premature tightening, makes fiscal and financial problems worse, and raises prospects for dangerous political reaction to policy failure.

True, the quantitative easing measures undertaken by the world’s central banks since late 2008 have not created a strong, sustained recovery. I warned in October 2009 that mechanistic monetarism could not be relied upon, that the stimulus from the stock of assets kept on central banks’ balance sheets would diminish faster than many expected, and thus that the only way central banks would know that they had made sufficient asset purchases was when the sustained recovery of domestic demand was achieved. That is an argument for G7 central banks to purchase more assets, while removing any fears of overshooting with such purchases. It is not a reason to give up on the effort.

The evidence is clear that the Bank of England’s and the Federal Reserve’s asset purchases had a positive significant effect on consumption, on the relative prices of riskier assets, on credit availability, and on liquidity in the financial system. If the improvement was insufficient, because the response to a given injection was less than some hoped, increase the dose.

There are no negative side-effects to speak of from greater asset purchases, beyond some politically induced nausea (which central bankers simply have to suffer through). In the 2-1/2 years since QE began to be felt in earnest, the trade-weighted pound has been flat and the trade-weighted euro has fluctuated but is within 5 percent of where it was.  The trade-weighted dollar is down 10 percent since January 2009, which is not that much all considered, and some if not most of that decline is due to downward revisions in the U.S. outlook, leaving little due to QE I or II.

Thus, all the claims of gold bugs and defenders of undervalued exchange rate pegs that QE was debasing the currencies of activist central banks have been proven unfounded. We should talk about asset purchases as what they are: mega-supplements for economies with a severe temporary deficiency of vitamin D (for demand). In other words, there are limited economic side effects because asset purchases are not at all unconventional for central banks, as many monetary theorists and historians have pointed out. The only exception is the scale required, which is determined by the size of deficiency.

Yes, inadequately restructured financial systems and real estate markets do inhibit the transmission of monetary stimulus by whatever means, as well as constraining growth directly.  Further monetary easing, however, makes it easier at the margin for deserving borrowers to get around the impairment of the banking system, and for banks to raise the higher capital they definitely require. Were elected governments to undertake the desirable reform of banks and resolution of real estate overhangs, central bank provision of liquidity would ease the uptake of risky lending that followed — with positive feedback on the effectiveness of monetary policy in turn.

Similarly, fiscal mismanagement does offset monetary efforts to reduce interest rates and anchor inflation expectations. Whenever central banks go beyond lecturing, however, into threats of withholding stimulus to try to compel elected officials into fiscal rectitude, they fail.  That is what the Bank of Japan mistakenly and futilely tried during the 1990s; that kind of structural failure is arguably a major source of the euro area’s underlying difficulties.

The appropriate response by monetary policy to the fiscal situation is to ease so as to keep recession from sabotaging fiscal consolidation or making budget disputes intractable. In any event, monetary policy in the G7 has to take as given that the major economies will undertake fiscal contraction at an average annual rate above 1.5 percent of GDP for the next couple of years — and when integrated economies simultaneously move fiscal policy in the same direction, the multipliers on that policy increase.

When you are the goalkeeper, there is no excuse for inaction, even if it is embarrassing when some shots do get past you, and even if your teammates fail to play defence.  Additional monetary stimulus is the last line of defense for the advanced economies today. G7 central banks should purchase more assets if we are to have any hope of our economies ever catching up.

9 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

This author is a fool, who has no understanding of economic history. Obviously, printing money debases the existing money stock, yet he denies it. In the normal business cycle, cash is supposed to be king in a downturn, with low asset prices so that control of economic assets can be shifted to more prudent hands, and out of the hands of those who caused the downturn. Yet, both in the UK and the USA, stock market values are wildly inflated, cash is NOT king, and if and when any tepid recovery occurs, inflation will be in the triple digits.

In the early years of the United States and, at about the same time period, in the UK. The penalty for monetary debasement was to hang until dead. Now, in a perversion of justice, men like Posen are bandied about as “respected” economists, even though they are actually shills who are accomplished pick-pockets for the casino-bankers who want to steal money from the common man. Such thieves are allowed to move in high society when they should be put on trial. Such men must be tried for treason, and the appropriate punishment, which I suggest can only be the same one we had in the past, should be appropriately applied.

Posted by ttolstoy | Report as abusive

I should say one more thing. This guy is not only a thief, but also a liar. Everyone who lives in the US and the UK knows that prices are rising very rapidly, yet he denies that there is any inflation. I just tried to rent a car in a city in America. They want $240 for a one week rental. Back in 2000, I could rent cars regularly, in that same city, for about $130 per week. The price of meat, milk, flour, corn and everything else has exploded.

The only things that are not being subjected to runaway inflation are the assets that are held by casino-bankers, such as stocks and real estate. That is because those things were wildly overpriced to begin with, as a direct result of the intense and repeated manipulations of those same casino-bankers who have hired Posen as their multi-million dollar “consultant” or will do so in the future.

The only way to end the thievery that men like Posen represent is to impose the appropriate penalty for their actions in monetary debasement, as described in my prior comment.

Posted by ttolstoy | Report as abusive

Brilliant article, very well argued. Adam is the expert’s expert on Japan. The Fed is now the only game in town. Ever since QE2 ended, the carry trade has gone in the dumpster, and Europe has hit the wall. We need both the ECB and the Fed to get a grip on reality and get busy or the down spiral will gain momentum. Thanks Reuters for this piece.

Posted by DanielKw | Report as abusive

The problem with printing money is that the underlying problems causing the lack of confidence and negative demand shocks are non-monetary. Printing money massages the figures, and massaging the figures will prevent the real underlying problems being fixed.

Military overspending, political corruption, public indebtedness, withering infrastructure, oil dependence, deindustrialisation, the withered remains of multiple bubbles, bailout culture, the derivatives-industrial complex, food and fuel inflation, the agency problem, and so forth.

http://azizonomics.com/2011/08/27/keynes -bernanke-krugman/

Posted by spiral_eyes | Report as abusive

“If the improvement was insufficient, because the response to a given injection was less than some hoped, increase the dose”.

Or the patient is dying and no amount of medicine will revive him.

Spiral_eyes knows how complex the body of the patient really is. And the patient may have so many things wrong with him but the doctors can only treat him with their limited range of medications and don’t want to admit there are other diseases at work.

Because the Fed has to buy treasury bonds isn’t that as much as saying that no one else really wants them and that their value is almost theoretical?

One could say the patient is rejecting the medicine at whatever dosage or it might be the wrong medicine.

Posted by paintcan | Report as abusive

What does “recovery” look like-another asset bubble of some sort, credit for flakes, redistribution of wealth according to someones world view, a bridge to nowhere?? I’d make the case we contract spending and raise some taxes until we move closer to balanced budgets across the country! We have no business speculating/gambling with the last of our credit/wealth and projecting some pie in the sky outcome based on some optimistic sweet talkin dreamers! A vision without a way to pay for it is dangerous now, a spending spike won’t work like it has in the past (fool my twice) and there is no substitute for cuts for years and tax increases based on local needs! I suspect we’re all looking at 4 day work weeks, far fewer services/entitlements and much more personal responsibility for actions-the way it should be! Hope we come out the other end a better country with better morals/ethics!

Posted by DrJJJJ | Report as abusive

What does “recovery” look like-another asset bubble of some sort, credit for flakes, redistribution of wealth according to someones world view, a bridge to nowhere?? I’d make the case we contract spending and raise some taxes until we move closer to balanced budgets across the country! We have no business speculating/gambling with the last of our credit/wealth and projecting some pie in the sky outcome based on some optimistic sweet talkin dreamers! A vision without a way to pay for it is dangerous now, a spending spike won’t work like it has in the past (fool my twice) and there is no substitute for cuts for years and tax increases based on local needs! I suspect we’re all looking at 4 day work weeks, far fewer services/entitlements and much more personal responsibility for actions-the way it should be! Hope we come out the other end a better country with better morals/ethics!

Posted by DrJJJJ | Report as abusive

Spend borrowed (40 cents/dollar) deficit dollars in hopes there’s some mulitplier effect that creates revenue? Perhaps some short term increase, but we’re all buried in debt and younger folks (not all) don’t feel like working overtime for life to make up the difference if we’re wrong! I’d place my bet on knocking down debt before we experiment with the last game (fed) in town!

Posted by DrJJJJ | Report as abusive

Well if you work for a monetary regime on the cusp of an integrated collapse, wouldn’t you incent it to fail outright and still make money doing it?

From their perspective, it’s time to wholly collapse the fiat regimes dated to 1971 and create a new one.

Here’s a quote from a good NFL coach, Denny Green: “The great thing about America is that everyone is entitled to an opinion, another great thing about America is you don’t have to listen to them.”

Here’s my take – I’m not listening, being American. The English can have their inflation and eat it too.

Posted by aboriginal | Report as abusive