A friend of mine sent me this article (http://truth-out.org/news/
The reason central banks are doing quantitatively easing is that they, as they are set up right now, do not have the ability to pump money into the real economy, not that they are purposely trying to bail out their buddies at the banks. There are two major reasons:
The reason central banks are doing quantitatively easing is that they, as they are set up right now, do not have the ability to pump money into the real economy, not that they are purposely trying to bail out their buddies at the banks. There are two major reasons:
1) They do not have the organisational infrastructure to do so (no central bank has the ability to acertain the credit quality of individual borrowers, so they can't directly lend money to us, which would be the most effective way of transferring money); and
2) A finance-led economic crisis by definition means that the economy had too much debt, and given that banks create money by lending (i.e. you need an economy which is already overlevered to borrow more), they have a difficult time to push money onto people who are already overextended. The banks wouldn't want to anyway, as they have to clean up their own loan books first, and why would they want to lend when the economy is in recession (so you cannot blame them for locking cash into reserves if they do not see economic activity picking up)?
The reason the central banks have been trying to help the banks is that that is what they understand. They are trained to assist in the creation of more credit in order to get the economy going, and as they understand it, that means helping the banks. As the banks are overlevered and have lots of bad debts, a powerful way of solving this problem is to increase profits. More profits equal more balance sheet capacity to lend and to write off bad debts. This works well but works slowly, usually taking several years in order to solve the banks' overleverage problems. For Europe (which was more overlevered), you're probably looking at over a decade, whereas the US seems like it should more or less clean itself up within the next couple of years (it's already recovering but is being impaired by the incompetence in government, which is a different problem).
Given that the economy is too weak after the Great Recession to wait several years for a lending-led recovery, the central banks use quantitative easing to buy assets directly, either from banks or from tradeable markets. This is what is causing asset prices to go up at the moment. The central banks was to achieve three objectives with this:
1) Because the central bank traditionally helps create credit to stimulate the economy, they don't know very much about how to deal with the equity side (by equity, I mean people's actual net wealth). By buying securities from people, they want to unlock the equity invested in those securities to channel it to other parts of the economy, thereby stimulating the economy;
2) Pushing up asset prices means that it is easier for banks to offload these securities and reduce their leverage to strengthen their balance sheets, improving their ability to lend; and
3) Pushing up asset prices hopefully improves sentiment, thereby getting people to start borrowing, investing, and spending again.
But as you can see, all of the above provide a basis for economic recovery, but none of them provides an actual catalyst for improving sentiment. This is where Ben Bernanke's "helicopter" theory of throwing out money comes in (it's based on Keynes's idea of burying money for people to go find it to stimulate activity). Giving money to people directly increases their net worth to spend or invest, so it's the fastest way to improve people's financial situations. But no central bank has the capacity or the authority to give people money directly. So that's why they fund government spending by buying Treasury bonds directly, so that the government can spend money or give people tax reductions to put more money into their pockets. This is effective up to a point and is why it is wrong for governments to be pushing austerity when sentiment and people's financial capacity are so weak. This in the mistake policymakers made that caused the Great Depression, hoping that restoring strength to the financial system and to government finances would improve sentiment. But this process itself hurt sentiment so much that banks didn't want to lend and people didn't want to spend, putting the economy into a death spiral.
As I said, this process of central banks funding government spending works up to a point, and this is where the advocates of central banks funding unlimited government spending (similar to the post-World War II "Keynesian" model) are really wrong. The money we have is an illusion; it's only because we place faith in it that is works. What faith do you put in the money when the government is throwing it out of helicopters? Equally, if the central bank wants to finance government debt to say 200% of GDP it has no problem with doing it, but what will people make of the worth of the money, especially if they aren't seeing the benefits directly? Unfortunately, I have had difficulty getting people to understand this concept because people have faith in money until they don't. The economic system works fine and is beneficial until people start questioning the value of the money itself, then all hell break loose, e.g. people had confidence in Greek bonds until they didn't. When government debt is say 200% of GDP, regardless of whether the central bank owns it or not, people will likely suspect that the government will just keep printing more money to pay that off. This is what happened in Germany during the Weimar Republic, when people lost faith in the currency and demanded more as compensation (causing massive inflation), so government had to print ever more money to keep up.
The biggest problem with this is that it results in a massive transfer of wealth from savers to debtors, since both debts and savings are devalued. The rich will dump the currency and go elsewhere, while the government will usually step in to help the poor. This leaves the middle class to take the brunt of the effect of currency devaluation. And it dramatically impairs economic activity and productivity growth; why would you save money to invest rather than spend it immediately if the money is going to devalue? It can be argued that it was the middle class's loss of confidence in the government which allowed the Nazis to come to power in Germany.
Going back to the issue of stimulating an economy, activity picks up when people 1) see value in investing, 2) see momentum in an economic recovery and want to jump on the bandwagon, and 3) feel secure enough in their finances to spend and consume. If there's not at least one of these catalysts, then there is no recovery. So it good that the central bank and the government pump money into the system 1) to arrest the decline and 2) to stimulate at least one of these catalysts. Buying financial securities is only in indirect way of doing this, so the central bank cannot directly influence the catalyst themselves.
A better idea than getting people to borrow more is to have the central bank invest in the equity of projects and banks. Why should the central bank not get the equity upside of projects if it is lowering interest rates and making it cheaper for these projects to be done? This injects equity money into the part of the economy where it is most needed, i.e. in capital goods, which declines the most in a recession but accounts for much of the productivity improvements in an economy. The trick is 1) to not replace or delay viable projects which could have been done by private or government entities in the first place, and 2) to make sure the projects themselves provide a necessary benefit to society given their cost (likely will need to partner with private investors or government on projects). This injection should only occur in the down cycles in the overall economy when it is most needed, as it is obviously less efficient than a free economy would be under better circumstances, though it is significantly more efficient than throwing money out of a helicopter.
Central banks can also inject equity into banks to strengthen their balance sheets. This would speed up the clean up of their balance sheets so that they are ready to make new loans more quickly. The trick here is that the central bank's equity holdings will need to be politically independent, i.e. they shouldn't dictate where the banks should be lending.
Why don't the central banks participate in the equity of banks and projects? The culprit is the people; they've been burned by poor government decisions in spending money in the past. So there needs to be a preset framework for how these processes will function. Also, this type of equity injections should only occur in a deep recession, i.e. only instances like the Great Depression or the Great Recession. That way, the private and government sectors cannot usually count on the central bank to come bail them out, as this type of draconian measure is usually not needed for most recessions.
No comments:
Post a Comment