Limits to monetary policy

There is a limit to monetary policy. Once the central bank has bought everything then we will have hit the limits of monetary policy.

When the company you work for is owned by the central bank and the pub you drink in is owned by the central bank and your pension fund is owned by the central bank, then we may start running into difficulties. How can the central bank inject money into the economy when it has already bought the shoes off your feet? Then we might have a problem. We are nowhere near the point where central banks are out of ammunition. Such a position shows a poverty of imagination.

There are a couple of straightforward ways for monetary policy to boost growth when an economy is depressed, one is to increase the amount of money chasing the  goods that have been produced. When an economy is operating well this simply increases prices, rents and wages without anybody actually getting better off. When an economy is depressed people don’t simply increase prices, rents and wages, they use the spare capacity available to bring more goods, land and people into employment. This is what a recovery is.

The other way of looking at it, would be to see this as a devaluation of the currency vis a vis other countries. This makes imports more expensive and exports more competitive. This shifts production to produce more exports and import competing goods and promotes growth. Is monetary policy impotent to generate either of those effects? Hell no!

If monetary policy is impotent to increase demand and the amount of money chasing goods, then the Bank of England could make the whole stock of national debt vanish without anybody suffering ill effects. If monetary policy is out of ammunition then monetising £1 trillion will have no effect on prices, rents or wages, and will just  reduce future expected taxes. That sounds a little too good to me.

While we at it, we may as well solve the European sovereign debt crisis, if monetary policy is impotent to affect a devaluation we may as well print enough pounds to buy enough euros to retire every continental nation’s stock of debt. If that doesn’t devalue the pound and boost exports I don’t know what will.

Frankly, the idea that somebody with a printing press, capable of producing money which is accepted around the world and for all imaginable goods and serves is unable to increase economy wide spending is laughable.

Of course, nothing is that simple, a central bank that went on a spending spree could always reverse its stance and suck the world dry of currency. The expectation of this reversal would seriously dent the efficiency of easily reversible actions like QE. However, that does not mean we should abandon QE it means we should pair it with a nominal target, a commitment device, like a nominal GDP level target to stabilise expected and current demand.