By Damien Grant
The medical profession no longer drills holes into fevered skulls because science has demonstrated that such measures do not work, often kills the patient and usually leaves a shocking mess in the surgery.
When it comes to economics, however, there is no shortage of amateurs recycling discredited miracle cures: deficit spending and printing money.
Bryan Gould has been complaining that austerity does not work and is no solution to our current woes, he points to Greece, Spain et al, to illustrate his point.
Greece, however, is a mess precisely because they have never practiced austerity. Greek governments used to print drachmas, and lately borrowed Euros. If borrowing money was a path to riches then Greece would be a wealthy country. It isn’t.
Greece has enjoyed two decades of fiscal expansion and is now broke. Like the other pigs in Europe’s sty, Greece gouged too long at the trough of cheap money. Further fiscal expansion is no longer an option because no one will lend her money. She cannot pay back her creditors; the only question is how large and messy the default will be.
This default is a gift to Greece, a modern Marshal Plan on a vast scale, taking from the prudent and giving to the indolent. So how, exactly has two decades of fiscal expansionary policies and a free hundred billion euros worked for Greece? Total failure.
Gould and others then turn to the United States and exult at the recovery, the fruit of several years of massive expansionary expansion, but fail to grasp the underlying unsustainability of this recovery. The United States is employing the same failed policies that ultimately destroyed the Greek economy, it has simply yet to hit the limits of its creditors patience. But it will, or it will impose sufficient austerity to balance its budget. Those are the only choices short of printing money.
The advantage that nations like the United States and New Zealand have is that we still retain significant creditor support, allowing us to employ fiscal expansion during a down turn. What has destroyed Greece is that she employed Keynesian fiscal expansion at all stages of the economic cycle and now has no economic headroom.
Gould, for his part, seems under an illusion that our government is currently running an austerity model. Treasury, by contrast, tells us that tax receipts are a billion dollars lower than forecast and we are running a 13.6 billion deficit, nearly seven percent of our Gross Domestic Product, with no end in sight. This is not austerity; that is how the Greeks bankrupted themselves.
Central government needs to cut government spending by 13.6 billion dollars, or the diminishing pool of tax payers need to pay more. Twenty two percent more, in fact.
That sounds unpleasant, which underlies the appeal of Gould and Hickey’s solution: printing money.
The easy criticism of printing money is that it leads to inflation but, as Hickey points out, this has not been the case in Japan where the central bank has employed quantitative easing for over a decade with no inflationary effects, and to the United Kingdom and the United States were recent expansions of the money supply has not trigged bouts of inflation or even inflationary expectations.
Japan has its own unique problems, the main two being an ageing population and government debt equal to 200% of Gross Domestic Product. A nervous, frugal, ageing population is hoarding a vast reserve of cash. In a reversal of how the Greeks got into trouble Japanese governments first attempted to revive a moribund economy by deficit spending. This did not work but left Japan with a massive debt, so the government began printing money, which the citizens hoarded rather than spent or invested.
The desire to hoard cash in Japan is so strong if the central bank did not print money Japan would be experiencing deflation. Clearly, the issues facing Japan are not relevant to New Zealand.
In both the United States and the United Kingdom programs of quantitative easing have not resulted in run-away inflation but it is not clear that they have led to a recovery either, however it is important to understand the special nature of printing money that is quantitative easing.
The central bank buys assets from the public, let’s say a treasury bond. The seller gets a credit in their trading a bank, and the trading bank gets a corresponding credit in the central bank’s ledger. Because the central bank has entered the market for treasury bonds, the yield for these falls, lowering interest rates. The balance sheet of the banking system is improved because, unlike a private seller, there is no corresponding debit in the purchaser’s account.
In both the United States and the United Kingdom the trading banks were pretty sick before the first tranches of quantitative easing, the effect of these programs was more about preventing a banking and possibly wider economic collapse than reviving their respective economies. It should also be noted that asset prices, mainly the share market, remained buoyant because of Quantitative Easing. Share prices are excluded from CPI calculations.
The mistake Messer’s Hickey and Gould are making is to confuse the effective use of Quantitative Easing to prevent economic collapse with using it to stimulate economic growth.
It is important to remember why printing money worked; citizens were tricked by inflation into thinking that the economy was improving. They responded by spending and investing, causing the real economy to expand, but never as much as the level of inflation created. Once citizens learned that inflation was occurring it was only inflation higher than they expected that could trick them into spending and investing.
Today, however, people like Bernard Hickey ensure that citizens know all about printing money! There is nowhere for Alan Bollard to hide a few billion dollars. So, what will happen if we were to employ quantitative easing in New Zealand?
Two things. Where there are constraints in the economy, inflation. No question. A short-term fall in interest rates will feed into house price inflation faster than a real estate agent can sneeze. Asset prices, all asset prices, will rise. This will mean that those with savings denominated in New Zealand dollars will be poorer, those with assets denominated in shares, property or other affected assets, will benefit.
Where there are no constraints in the economy, such as employment, wages and prices will stagnate. Meaning those people will be poorer relative to those benefitting from an increase in asset prices. There will not be any rush of new spending.
This is a redistribution of wealth, from savers to borrowers, from workers to speculators, from the frugal to the feckless.
Damien Grant is a Herald on Sunday columnist.
A shorter version of this story first appeared in the Herald on Sunday.