Is Quantitative Easing “Excessive” and “Passé”?

 Much discussion has been going on lately about the stance of the Fed’s monetary policy, the near zero interest rate or QE (quantitative easing) policy. Given the relatively positive numbers characterizing the American economy in terms of predicted growth rates and lower unemployment rates, Janet Yellen has decided, reluctantly it seems, to modestly raise federal funds rate from 0.25 percent to 0.50 percent. As noted by Bloomberg “ that’s still way below its 2 percent average since 2000 and the 3.2 percent of 2000 to 2007.”

But is the state of the US economy the right indicator for the required monetary policy of the premier currency of the world economy? Is, in other terms, a purely American debate the right framework for analyzing the optimal supply of the main “vehicle” currency in world trade? Of course a few other currencies are also used in international trade and as reserve instruments, such as the euro and the Japanese yen. Monetary authorities in control of both are currently implementing QE policies.

And as noted again by Bloomberg, JPMorgan Chase & Co.’s average interest rate for eight developed nations and the euro-area weighted by size is on course to end 2016 at just 0.36 percent. That’s a full 3 percentage points below the average of 2005 to 2007, which could mean that expansive monetary policies are still implemented worldwide.

However, a slowing down of the dollar supply could well affect negatively the world economy at a time when its overall performance is lackluster, and almost zero or even negative inflation rates generally prevail. 

That said, are the fears of QE policies having been somehow “excessive” before and after the 2008 crises, feeding “unsustainable” asset bubbles all around the world that are waiting to burst, creating the conditions for a devastating new financial crisis, warranted? And what about, on the other hand, of the environment of “great stagnation” and insufficient inflation worldwide?

A quick look at the evolution of both monetary aggregates and trade growth rates in the world economy, as reported in the table below, gives a different picture of a monetary expansion barely sufficient to sustain the growth of world trade. If vindicated by more precise study of data, that could be a factor in explaining the now long, post 2008, “great stagnation” and such a hypothesis would warrant further quantitative easing by the three main central banks for some time to come.

     

                                              Aggregate Growth Rates

                                              2005-2014        2008-2014

M1 (OECD total)                   + 193 %              + 166 %

M3  (OECD total)                  +  171 %             + 135 %

M1  (Euro Area)                                                 + 152 %

M3   (Euro Area)                                                +  110 %

                                                                   

World Trade (Exports, Merchandises and commercial services, WTO data)

                            

                        1995-2014      2005-2014

                           + 376 %           + 183 %

The overall, although admittedly impressionistic, conclusion that one can derive from these data is that monetary expansion was just sufficient to sustain the growth of world trade, and maybe insufficient post 2008.

The current need would thus be one of a prolongation – rather than an interruption -- of QE policies, US included. It could be that each central bank narrowly concentrating on the sole state of its own economy, missed the overall picture of required increases in international liquidity.

How Japan Was Saved From the Gold Standard … and the Great Depression

A Professor in Economics and Director of the Centre of Full Employment and Equity, at the University of Newcastle, NSW, Australia, Bill Mitchell has just posted on his blog – Billy Blog: Modern Monetary Theory … macroeconomic reality – an extremely interesting analysis of the Japanese monetary policy in the early 1930s.

His post of Tuesday, November 17, reminds us that Takahashi Korekiyo, a Finance Minister and then 20th Prime Minister of Japan in 1932, was a Keynesian of sort even before Keynes published his General Theory, and that he saved Japan from the Great Depression.

Takahashi Korekiyo is famous for abandoning the Gold Standard on December 13, 1931 and introducing a major fiscal stimulus with central bank credit that rescued Japan from the Great Depression in the 1930s.

His policy introduced three notable sources of stimulus at the time:

1. The exchange rate was devalued by 60 per cent against the US dollar and 44 per cent against the British pound after Japan came off the Gold Standard in December 1931. The devaluation occurred between December 1931 and November 1932. The Bank of Japan then stabilized the parity after April 1933.

2. He introduced an enlarged fiscal stimulus. In March 1932, he suggested a policy where the Bank of Japan would underwrite the government bonds (that is, credit relevant bank accounts to facilitate government spending).

On June 18, 1932 the Diet adopted the government’s fiscal policy strategy for the next 12 months with a rising fiscal deficit, 100 per cent funded by credit from the Bank of Japan.

Bank of Japan historian Masato Shizume wrote in his Bank of Japan Review article (May 2009) – “The Japanese Economy during the Interwar Period: Instability in the Financial System and the Impact of the World Depression” – that:

“Japan recorded much larger fiscal deficits than the other countries throughout Takahashi’s term as Finance Minister in the 1930s”.

3. The Bank of Japan eased interest rates several times in 1932 (March, June and August) and again in early 1933. This easing followed the cuts by the Bank of England and the Federal Reserve Bank in the US. Monetary policy cuts were thus common to each but the size of the fiscal policy stimulus was unique to Japan.

As noted by Bill Mitchell, “a number of observers who focused on the macroeconomic aspects of the Takahashi economic policy praise his achievements as a successful pioneer of Keynesian economics. Kindleberger points out that Takahashi conducted quintessential Keynesian policies, stating that: “his writing of the period showed that he already understood the mechanism of the Keynesian multiplier, without any indication of contact with the R.F. Kahn 1931 Economic Journal article”

As noted by Bill Mitchell, “a number of observers who focus on the macroeconomic aspects of the Takahashi economic policy praise his achievements as a successful pioneer of Keynesian economics. Kindleberger points out that Takahashi conducted quintessential Keynesian policies, stating that: ‘his writing of the period showed that he already understood the mechanism of the Keynesian multiplier, without any indication of contact with the R. F. Kahn 1931 Economic Journal article’.”

The complete post is well worth reading here. 

Thanks to Kamil Kaminsky for mentioning this blog and post.

Real Effects of the Euro: A Comparative Analysis

Matthew C. Klein has written an excellent paper showing how the euro has failed to bring about the benefits for all that it was supposed to confer to the eurozone members, in 'The Euro as Pointless" in the Financial Times of November 11.

“It’s easy to forget now, but the single currency wasn’t created purely as a political project.

Many economists in the 1980s and 1990s thought monetary union would encourage cross-border investment and trade by eliminating the risk premiums associated with the supposedly destabilising devaluations of the past. The net effect would be converging living standards, dampened business cycles, slower inflation, and faster productivity growth for everyone — the benign Germanisation of Europe.

This was a laudable goal, but unfortunately it’s not how things worked out.”

This is precisely what I showed in my 2002 paper “l’euro, tout était faux”, an early analysis of that failure here.

Excerpt from Klein’s conclusion:

“In retrospect, it’s clear the euro simply shifted risk from exchange rate fluctuations to defaults (for foreign creditors) and nominal income (for domestic workers and businesses). This wasn’t sufficiently obvious at the time, however, or we wouldn’t have seen such massive growth in cross-border banking and portfolio flows within the currency bloc before 2008.

Contrary to what the euro’s founders believed, it now appears the absence of monetary union is what’s needed to channel capital flows most productively across borders. That’s the real tragedy of the single currency: it was pointless from the start.”

Highly recommended.

Catalonia’s Independence as seen by Economists

 Spain’s economy was supposed to be improving on its way to a successful recovery from the depth of the southern European crisis. Now the results of the regional election in Catalonia testify to a deep malaise still pervades the country. And many people wonder what happens and what Catalans want. 

A few economists provide some serious answers to that question.

Economic historian Joachim Voth has a public finance story that is purported to explain the claim for secession in Catalonia in “Want to know why Catalans want to leave the loving embrace of Spain?”

On his blog Vothspeak here.

Xavier Sala-i-Martin, at Columbia University, has also an interesting story and mentions other work by fellow economists on the question of potential viability of an independent Catalonia, here.

He concludes that:

“It has been argued that, as time goes by, the desirability of having smaller nations increases. And the economists who say so are not (I repeat, NOT) some crazy Catalan nationalists. They are Harvard University professors Alberto Alesina, and Robert Barro and Stanford University professor Romain Wacziarg. These economists have demonstrated that the 20^th century trends of increasing trade and globalization explain empirically the increase in the number of countries that we have witnessed during the second half of the century. The reason? The growth in international trade and globalization makes it less desirable to belong to a larger political union like Spain. As globalization progresses, the need of one's industry to depend on a large local market is reduced. The gains from being small, on the other hand, remain the same. Hence, the optimal size of a country is reduced. Again, the scientists that say that are not radical catalan independentists, they are Italian, American, and French professors from Harvard and Stanford.”

A question of optimal organization.

I agree with all the above. But the main argument explaining the new independence movements gaining momentum in the past few years is that the information revolution that has swept the world since the mid 70s brought about an organizational revolution making smaller hierarchies more efficient than larger ones.

This is because market exchanges, an alternative to within-hierarchies exchanges, require a huge quantity of information while hierarchies economize of information, as Ronald Coase explained a long time ago (Coase, “The Nature of the Firm”, 1937).  It follows, as I demonstrated in my book “The Second Twentieth Century: The Decline of Hierarchies and the Future of Nations” (Grasset 2000, and Hoover Press 2006), that smaller firms and smaller nations are now more efficient than larger ones (the “Coase-Rybczinski” theorem). 

Globalization itself is an instance of expanding markets that results from cheaper information costs. Transport costs did diminish too, but not as much as information costs, so that the fall of the latter has been of an order of magnitude larger than the fall of the former.

By this argument, one can better understand the implications of the change for the relationship between regions, nations, and the European Union. A standard argument in favor of a Federal Europe has been that it would constitute a move towards a more decentralized political and economic structure than the current national economies and polities on the continent. Not so, because the building of a federal superstructure on top of the current national ones would amount to an increase in centralization.

And the same factor that boosts regionalist movements within existing nation-states, i.e. the growing abundance of information, plays against the building of a larger, continental, hierarchical structure such as the European Union. A federal, integrated Europe, would thus contradict the decentralization trend at work in the early XXIst century, and would contradict at the same time the secession and independence trend that affects several European nation-states, visible in Italy (the Northern League) and Belgium (between Flemish and Wallon regions) as well in Great Britain (the movement in favor of Scottish independence, and the Brexit movement as well).

Indeed we observe both that the European integrative process has been stalling in the last decades, while regionalist and secessionist movements have been on the rise. The recent economic crisis still evolving after seven years (2008-2015) has boosted criticism of established parties and existing national political-economic structures in various European nation-states as well as in the centralized and would-be hierarchical European Union, because they are now obsolete and inefficient in organizational terms.  

The bottom line is that fundamental economic and organizational factors underlie the Catalonian independence movement and it will intensify rather than disappear in the near future. A new democratic fragmentation of the European space now appears likely.