Delivering economic stimulus addressing rising public debt and avoiding inflation

Description
The purpose of this paper is to review monetary policy options in countries assumed to be
suffering from two common economic problems: deficient private demand and high and rising public
debt.

Journal of Financial Economic Policy
Delivering economic stimulus, addressing rising public debt and avoiding inflation
Richard Wood
Article information:
To cite this document:
Richard Wood, (2012),"Delivering economic stimulus, addressing rising public debt and avoiding inflation",
J ournal of Financial Economic Policy, Vol. 4 Iss 1 pp. 4 - 24
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340-354http://dx.doi.org/10.1108/17576381111182918
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Delivering economic stimulus,
addressing rising public debt and
avoiding in?ation
Richard Wood
The Australian Treasury, Canberra, Australia
Abstract
Purpose – The purpose of this paper is to review monetary policy options in countries assumed to be
suffering from two common economic problems: de?cient private demand and high and rising public
debt.
Design/methodology/approach – The analytical approach assumes that relevant authorities have
decided that new money creation is necessary to address their economic problems. The paper asks the
question: how should this new money creation best be deployed to create the required economic
stimulus in the context of rising public debt?
Findings – The ?rst ?nding is that the latest rounds of “quantitative easing” in the USA (QE2) and
Japan are likely to be inef?cient, largely ineffective and have adverse side-effects, and that in periphery
countries the risk of debt default is being increased by current defensive policy settings. The second
?nding is that the policy of ?nancing budget de?cits by printing new money is likely to be more
effective (than “quantitative easing” and current Eurozone policy) in raising demand, output and
employment without adding unnecessarily to already high levels of public debt.
Practical implications – There are very substantial practical policy implications, involving a
potential change of monetary policy strategies for two of the world’s largest economies and for
Eurozone periphery countries. Post-earthquake reconstruction in Japan could be ?nanced in the
manner recommended in this paper.
Originality/value – The originality/value lies in demonstrating that current monetary policy
orthodoxy is misplaced, and that an alternative policy strategy has been overlooked and is likely to be
more effective.
Keywords Monetary policy, Macroeconomics, Public ?nance, Central banking,
Supply of money and credit, Monetary economics, Central bank policies,
Comparative or joint analysis of ?scal and monetary policy, Stabilization, Macroeconomic policy,
Macroeconomic aspects of public ?nance
Paper type Conceptual paper
1. Introduction
This paper considers how economic policy might respond to a worst-case economic
scenario, one that is already unfolding in some countries. In this scenario, demand and
output are contracting and public debt is already high and spiralling upward. It is
assumed that these developments occur across a number of countries at around the
same time.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – E5, E52, E58, E6, E63
The author is grateful to Phil Garton, Megan Thomas, Max Corden, Gerald Dodgson,
Martin Gould, Timur Behlul and Nicole Elsmore for helpful comments and advice. The author is
solely responsible for all ideas expressed in this article, which are not necessarily shared by his
employing agency. This article was originally accepted for publication on 8 June 2011.
JFEP
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Journal of Financial Economic Policy
Vol. 4 No. 1, 2012
pp. 4-24
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/17576381211206451
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The immediate subjects of this paper are the monetary policies of the USA,
Japan and the Eurozone periphery countries. Other countries, for example, the UK,
France, Belgium and Hungary, may also eventually become involved.
Typically to date, an asset (property) price boom-and-bust and a banking
credit-and-debt crisis preceded economic recessions. As with earlier ?nancial crises,
public debt has risen strongly (Reinhart and Rogoff, 2010) and this high debt is
becoming a source of increasing concern, contributing to rising sovereign debt risk
premia, credit downgrades and, in the case of periphery countries, the possibility of debt
restructuring, moratoriums, defaults and/or exits from the Eurozone[1].
Fiscal tightening, rather than further strong ?scal stimulus, is underway in Europe,
and may now be likely in the USA as well (including at state and local government
levels). Severe austerity programs will weaken aggregate demand and tax revenues,
slow economic growth and raise unemployment further[2], particularly in the short-run
(which is the time frame that counts most in a crisis). These developments will, in turn,
put renewed upward pressure on government budget de?cits and public debt. This
pernicious cycle will be occurring at a time when further policy stimulus should be
applied. In such circumstances, an economic plan that provides economic stimulus
while substantially constraining the growth in public debt is worthy of careful
consideration.
Despite today’s fundamentally transformed economic circumstances in Japan and
the USA, the most recent modus operandi of monetary policy authorities in these
countries is to extend and adjust the basic interest rate paradigms used during the
great price moderation and work, via increased bond or asset purchases under
“quantitative easing”, to ?nance further reductions in interest rates and yields[3]. The
great risk now, however, is that the further application of this policy, in the current
environment of historically low interest rates and debt overhangs, will be inef?cient,
largely ineffective and generate adverse side effects[4, 5].
Within the tightening Eurozone shackles, a number of periphery countries are
unlikely, generally, to be able to raise either net exports or internal demand suf?ciently,
or otherwise grow their way out of their debt crises. In such circumstances, there are
two general options.
First, retain the Eurozone in a more deeply federalised and modi?ed form, spreading
“debt risks” and liabilities as widely as possible. This option is fraught with potential
dif?culty. Germany would be required to share its wealth and spoils, and the periphery
countries would be required to give up remaining economic sovereignty, and pursue
draconian, rules-based ?scal policies. Wage and price rules would also seem necessary
in periphery countries to avoid the mistakes of the past. However, economic growth in
many periphery countries could not be expected to recover suf?ciently in the short- to
medium-term under a policy regime involving a ?xed Euro exchange rate and ongoing
?scal austerity. With economic growth negative or non-existent, current debt interest
commitments due on existing public debt would be suf?cient, alone, to drive public
debt even higher. Furthermore, to save the Eurozone, the European Central Bank
would need to be prepared to buy large volumes of distressed government bonds –
adding frightening levels of risk to its own balance sheet – and to bail-out commercial
banks, which risk becoming insolvent at some point, due to their large sovereign bond
holdings. Selective debt rescheduling, or a debt moratorium, may better stave-off
collapse and buy needed time for restructuring.
Delivering
economic
stimulus
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The second option is for affected periphery countries to leave the Eurozone. The
second option would allow national periphery governments to re-establish sovereign
currencies and their own monetary policies. The depreciated local exchange rate, and
other tools, including monetary policy, could be used in conjunction with prices and
incomes policies to improve competitiveness, pro?tability and demand, and, through
those channels, provide a foundation for the resumption of economic growth without
further raising current account de?cits. In some countries, however, things may have
already gone too far. That is to say, a sovereign debt default may ultimately be
inevitable, which could be disastrous for some banks, but not necessarily undesirable
for the country concerned.
Substantial adjustments – in the North and in periphery countries – are required
under both options. However, the policy of exiting the currency union is arguably in
the best longer-term interest of some individual periphery countries. In this article,
nonetheless, we will assume that they elect to remain within the Eurozone, although
whether they remain in, or opt out, does not alter the relevance of the policy
recommendation developed in this article.
Today, debt problems are simultaneously evident across an unprecedented number
of industrialised countries and continents. The common near-term policy objectives for
the countries caught up in a “debt-stagnation” scenario should be to:
(1) create additional economic stimulus;
(2) stop public debt from increasing further; and
(3) meet in?ation objectives.
If slow-downs and contractions deepen then current policies are set inappropriately
and headed in the wrong directions.
To reverse such disturbing and unsustainable trends, the underlying policy
paradigm would need to be changed. Policy makers would need to ?nd room to run
budget de?cits at higher levels than would otherwise be the case in order to create
suf?cient ongoing economic stimulus to counter falling disposable incomes and
weakening private demand. Fiscal stimulus would be required, inter alia, to provide the
capacity for continued debt de-leveraging in the private sector, and to support
the unemployed and incomes until ?scal consolidation could be safely resumed. If
the budget de?cits required to provide this stimulus were to be ?nanced by the
conventional method – sales of new government bonds – then interest rates and
public debt would both increase. If central banks attempted to directly ?nance the
budget de?cit, as proposed by Bernanke (2003) for de?ation-prone Japan, there would
also be an increase in public debt as it is de?ned. These two approaches, therefore,
would clearly con?ict with public debt objectives, and compound the posited economic
dif?culties.
In this article, “publicly held debt” is de?ned as government bonds held by private
individuals and business residents and non-residents, but it does not include
government bonds held by the central bank, which are assumed to form part of “public
debt”. For purposes of exposition, “current” public debt is de?ned as being equivalent
to total public debt minus “perpetual” public debt. “Perpetual” public debt is assumed
to arise whenever new money is created.
This article establishes a guiding economic policy principle: a monetary and ?scal
policy combination that may simultaneously resolve two problems – falling output
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and spiralling “current” public debt – is one where the Ministry of Finance (or the
Treasury) creates new currency to directly ?nance the budget de?cit. The article
explores the implications of this approach, and how it might be delivered in practice.
2. New-money-based economic stimulus policies
For countries with inadequate aggregate demand and de?ation, or an advanced
de?ationary tendency, policy-makers need to ensure that there is adequate growth of
the effective money supply. The policy question explored below assumes that an
appropriate authority has decided that money supply growth is inadequate and that
new money creation is necessary in order to work against de?ationary tendencies and
to stimulate the economy. The central policy issue becomes: how should such new
money creation best be deployed to create the required economic stimulus, in the
context of high and spiralling public debt? In the discussion below, two policy
approaches are contrasted to illustrate differences in policy objectives, choices and
effects.
2.1 Bond purchases on the secondary market: Policy A
Under Policy A, the central bank creates new currency and uses it to purchase
government bonds on the secondary market. Purchases of private bonds could also
take place[6].
The principal purpose of this action – which falls within the general policy
framework referred to as “quantitative easing” – is to ?nance a rise in bond prices and
to lower yields and rates of interest. The basic belief is that this policy will stimulate
economic con?dence, lending, investment and overall activity.
A signi?cant case can be mounted against the continued application of this policy in
current circumstances.
This policy would be more appropriate, and have greater value, if consumption
demand was adequate but investment was weak due to high real interest costs, the
economy was not caught in a liquidity trap and the real effective exchange rate was
signi?cantly overvalued. In current circumstances, these prior conditions do not exist
in the USA or Japan.
Rather, in general, short-term interest rates are already very low or at their lower
bound, business and consumer uncertainty is elevated, household and banking debt is
high, liquidity preference is strong, business pro?tability is buoyant, demand for
credit/loanable funds/investment is not constrained by high interest costs,
consumption and production are weak and house prices and core consumer prices
are sluggish or declining. In such circumstances, the further lowering of medium- to
longer-term interest rates toward their lower bound would be unlikely to raise housing
investment or otherwise substantially stimulate business investment or domestic
demand.
If the consumption/investment preferences of the bond holder are unchanged, as
seems possible, then under Policy A bondholders may purchase new domestic bonds
(or other close substitutes), or higher yielding foreign bonds (or foreign assets) offshore,
with the cash received from the central bank. On this basis, the additional money
supply would not go directly, if at all, to domestic consumers, wage-earners, the
unemployed, or to businesses in the non-?nance sector – the areas where it is most
needed to generate domestic demand growth.
Delivering
economic
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Beyond some point, additional reductions in longer-term interest rates will further
lower interest incomes of state and local governments, mutual funds, pension funds,
etc. including incomes of the elderly and retirees, and will, in turn, impact adversely on
consumption expenditure. At some point the return for not hoarding becomes too low,
and with uncertainty high and ?nancial and borrowing fears elevated, economic
agents – businesses, investors and consumers – may prefer to hold cash (safe
currencies and commodities) as a store of value (Keynes, 1936), rather than consume
and invest. Commercial banks may accumulate unproductive excess reserves as the
demand for new loans remains weak. As Pigou (1933) asserted:
It is indeed always possible for the Central Bank, by open market operations, to force out
money into balances held by the public. But in times of deep depression, when industrialists
see no hope anywhere, there may be no positive rate of money interest that will avail to get
this money used.
In today’s circumstances, this money will be hoarded as reserves by the private
banking system or as money balances by the public. Today, commercial bank reserves
held at the central bank in the USA currently stand at around $1.4 trillion, and earn
commercial banks 0.25 per cent per annum, “risk free”, to the bene?t of no other entities
or the broader economy. Business cash reserves in the USA stand at $2.4 trillion, and
pro?ts of US multinational companies held offshore stand at $1.4 trillion.
As medium to longer-term nominal interest rates fall toward their lower bound, the
margin between borrowing and lending rates may come under downward pressure,
making dif?culties for banks in terms of core activity pro?tability and their ability,
and willingness, to extend credit. As longer-term interest rates fall, insurance
companies, heavily reliant on interest income from their investments in low-risk,
longer-term government bonds, will be adversely impacted, potentially damaging the
effectiveness, risk and cost of insurance services.
As central bank holdings of government bonds on balance sheets increase (due to
“quantitative easing”), the low interest rate environment adds to the risk of substantial
capital losses when interest rates are increased. More generally, beyond some point,
further rises in bond prices could, as they approach their upper limit, set the stage for a
sell-off, or a slump in demand for US government bonds. This possibility could occur
as a consequence of an unanticipated economic shock. Such an event could be
disruptive to ?nancial markets and economic recovery.
Working (by excessive “quantitative easing”) toward an arti?cially ?at yield curve
based on a zero interest rate could impart misleading information about underlying
risk structures, distort time-dependent investment and purchasing/selling decisions,
and encourage banks to take on higher-risk positions to maintain yields and
pro?tability.
The likely effectiveness of Policy A is highly uncertain in its application. Available
estimates suggest that the latest round of “quantitative easing” (QE2, $600 billion) may
have lowered long-term bond rates by around 15-20 basis points. However, the
evidence regarding the channels through which large-scale asset purchases operate is
far from conclusive, and there is substantial uncertainty, even among central bankers,
about just how the portfolio channel actually works (Williams, 2011). In the USA and
Japan, the recent costly round of “quantitative easing” did not reach consumers, the
disadvantaged, those living below the poverty line or the unemployed, and it failed to
boost public infrastructure expenditure. As a result, it did not ignite private
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consumption and investment. There is little or no evidence that private investment
responded signi?cantly to the modest easing in long-term yields. Remaining market
forces, expectations about future in?ation rates, and the effects on interest rates of the
conventional method used to ?nance budget de?cits (selling government bonds), may
work against the announced monetary policy objective of lowering interest rates. Such
developments would further frustrate the ability of central bankers to demonstrate the
achievement of their announced policy objectives, impacting on central bank
credibility, and possibly tempting monetary authorities to launch yet further rounds of
“quantitative easing”.
The latest round of “quantitative easing” (QE2, involving bond purchases on
the secondary market), adopted by the US Federal Reserve Board in October 2010, has
another major disadvantage. The reduction in longer-term interest rates secured
under that approach will have resulted in an increased incentive for “carry trade” and
other actions designed to move funds offshore to higher yielding assets in foreign
jurisdictions, particularlyinEast Asia, SouthAmerica andcountries withrelativelyhigh
interest rates. These countries may ?nd such increased capital in?ow disadvantageous
as domestic in?ation there could increase, asset price bubbles could develop and local
exchange rates could rise.
If longer-term interest rates were to fall closer to zero, the likely effects on capital
out?owand the exchange rate could be relatively large in open economies. If Policy Ais
successfully applied, and the $US exchange rate falls at a time when global currency
tensions are strong, some may allege that the increase in the money supply has been
designed to create an undervalued currency. The cumulative application of such policy
would, therefore, progressively add to the risk of substantial capital out?ow; raise the
spectre of “beggar-thy-neighbour” policies; prompt trade and exchange rate retaliation;
provide incentives for the reintroduction of capital controls on international capital
movements (or dual exchange rates); and international economic policy coordination
could be undermined.
Under Policy A, government bonds are purchased on the secondary market and
publicly held debt falls, but that debt is simply transferred to the central bank’s
balance sheet – public debt does not fall. To the extent that the bonds are sold back
into the secondary market – in order to rebalance the central bank’s balance sheet and
raise interest rates from their arti?cially low levels determined under “quantitative
easing”, and to return them to more normal levels – publicly held debt increases again.
An ef?cient monetary policy should not have the effects of arti?cially manipulating
and lowering (temporarily) medium to longer term interest rates further when shorter
term interest rates are already at their lower bound. Such an approach extends the
liquidity trap out along the yield curve; raises commodity and share prices temporarily
to create “bubble-like” illusory wealth; supports stock-brokers and banks’ trading
desks; provides a “subsidy-like-payment” to commercial banks; and manipulates and
increasingly suppresses an important and ef?cient risk allocation mechanism, the term
structure of interest rates.
2.2 Fiscal stimulus ?nanced by printing money: Policy B[7]
In the era when many countries were ?ghting against strong in?ationary tendencies, it
became widely accepted that printing money should not be the means of ?nancing
budget de?cits. Some countries passed laws to preclude this possibility.
Delivering
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However, in current extraordinary circumstances – where prices are falling or in?ation
drops too low, unemployment is high, nominal short-term interest rates are at their zero
lower bound, and when budget de?cits are high and government debt is judged
excessive – a relatively strong case can be made for printing new money to directly
?nance ?scal stimulus.
Most central banks have limited scope to print new money in order to ?nance ?scal
de?cits in a manner which does not involve an increase in “public debt”, as it is de?ned
under current accounting conventions and adopted by credit rating agencies. Public
debt includes the government bonds held by central banks. The newgovernment bonds
that would be issued to the central bank in exchange for new central bank money
creation to ?nance a budget de?cit would be classi?ed as public debt. Credit rating
agencies “look through” and see that central bank-held government bonds are likely,
presently or at some future time, to be unwound and on-sold, or sold back, to the public.
In the case of the USA, some elements of ownership and control of the central bank
appear to be shared between government and private bank representatives. So in the
USA, the complication (that restricts a central bank’s ability to ?nance budget de?cits
without raising public debt) possibly extends beyond that of an “accounting
convention”. In the USA, it is arguable that the central bank could not under any
interpretation be viewed as part of the wider government sector, given this private
participation.
Under the proposal advanced in this paper, the Ministries of Finance (or the
Treasuries) in the economies concerned – say, the USA, Japan and the Eurozone –
could be given authority to print legal tender currency notes, as was, for instance, the
case in the USA prior to 1951 (with the “US Note”). This approach would effectively
by-pass central banks, and thereby avoid any increase in “current” public debt. This is
the approach recommended by this paper.
There are two models that could be adopted for this purpose (implementing Policy B):
.
Model 1. Ministry of Finance-created currency issued to the public
Under Model 1 the Ministry of Finance creates new currency which is used to
directly ?nance the budget de?cit. By this method, the Ministry of Finance-created
currency passes directly into the hands of the unemployed, the disadvantaged,
to public infrastructure projects, marginal businesses, etc. thereby entering into
public circulation.
The sole purpose in printing Ministry of Finance-created currency is to ?nance
the ?rst round of public spending. Beyond that, the Ministry of Finance-created
currency has no critical role.
It might be thought that having two sources of national currency would be
problematic, but this is not necessarily the case. Under the proposals advanced in
this article, the Ministry of Finance would be given legislative authority to create a
given quantum of new currency annually, say “Y” per cent of the budget de?cit,
where “Y” may be determined to lie between 0 and 100 per cent. The parameter “Y”
would be announced well in advance in the annual budget. The central bank
would then take that announcement into account when planning and undertaking
its own currency and securities trading operations. This tightly controlled
calibration, which could be incorporated in legislation, would ensure the monetary
creation capacity given to the Ministry of Finance is strictly limited and not
misused.
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It might be thought that some economic agents (individuals and businesses)
may be reluctant to accept the currency created and issued by some of the
Ministries of Finance (governments), say, in periphery countries with high levels
of public debt. Economic agents could view that holding such currency may be
risky, if they perceived that the government may not be able in the future to
redeem the currency at face value. In order to overcome this potential dif?culty,
the economic plan could require that the central bank fully support the plan,
and that, in the case of periphery countries, the European Central Bank provide a
commitment that commercial banks would redeem the Ministry of
Finance-created currency at the face value of the equivalent denomination of
central bank-created currency.
In reality, the only observable difference between the Ministry of
Finance-created currency and the central bank-created currency need be the
colour of the seal on the currency. This subtle physical difference would go largely
unnoticed by the general population.
.
Model 2. Ministry of Finance-created currency swapped for central bank currency
Under Model 2, the Ministry of Finance would create $X billion of Ministry of
Finance currency. At the same time, the central bank would print $Xbillion of new
central bank currency. The two currency tranches would be exchanged
electronically.
The Ministry of Finance would then hold $X billion of central bank-created
currency which could be used to ?nance the budget de?cit. The central bank would
have received an asset on its balance sheet, this being the $Xbillion created by the
Ministry of Finance.
The virtue of Model 2 is that it is far simpler and does not impose on the public,
as no Ministry of Finance-created newcurrency need ever circulate in the economic
system. This avoids the need to have two currencies circulating simultaneously.
Any risk of black market value arbitrage between the currencies would be avoided.
As with Model 1, there could be full, or partial, sterilisation over time.
Under Model 2, if there is 100 per cent sterilisation by the central bank, interest
bearing securities are sold into the market, and the perpetual liability created when
the new central bank-created currency was created is extinguished. At that point,
the central bank is left holding a “perpetual” asset in the form of the Ministry of
Finance-created currency, which is non-interest bearing, while the Ministry of
Finance holds the “perpetual” liability formed when the new Ministry of Finance
currency was created.
Assuming the plan results in an economic growth and tax dividend, the
Ministry of Finance would have additional resources to compensate the central
bank for interest not gained (due to the central bank holding Ministry of
Finance-created money rather than bonds) under Models 1 and 2. Such transfers
from taxpayer to the central bank are not lost to the economy, or the society.
Figure 1 shows the ?ows of currencies, sterilisation and the cancellation of the
perpetual liability under Model 2 (the swapping of currencies model).
With 100 per cent sterilisation then, with Models 1 and 2 there would be no increase
in publicly held debt or “current” public debt, but a perpetual liability would remain
on the government’s balance sheet. Under both Models, ?nance would be made
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available for tax cuts, increased transfer payments (including enhanced unemployment
bene?ts and extension of the eligible period for receiving unemployment bene?ts)
and/or additional public expenditure and infrastructure programs. The increased
money supply could potentially go directly into the hands of consumers, wage-earners,
the unemployed, the poor and other welfare recipients, those adversely impacted by
austerity programs (including those affected from severe expenditure cut-backs
initiated by state governments under “balanced-budget rules” in the USA), those whose
“wealth” and income-earning prospects have collapsed as a result of falling house
prices and foreclosures, and all sorts of businesses in the non-?nancial sector. Such
windfalls would be largely, or at least partly, spent on consumer goods or on business
investment, generating multiplier and accelerator effects[8].
Models 1 or 2 would be appropriate if domestic demand is de?cient, excess
productive capacity exists, unemployment is high and there is a desire to apply ?scal
stimulus without raising the levels of publicly held debt and “current” public debt.
These prior conditions are now presenting themselves in different degrees in the USA,
Japan and periphery countries. Models 1 and 2 direct new money creation to locations
in the economy where the marginal propensities to consume and to invest in real
productive assets (as distinct from ?nancial assets under “quantitative easing”) are
relatively high. Models 1 and 2, therefore, could be expected to impact favourably on
consumption and investment spending and provide greater capacity for de-leveraging.
Models 1 and 2 would also provide the time, increased incomes, suitable in?ation rates,
con?dence and appropriate interest rates needed to work out of liquidity traps.
Figure 1.
Model B: currency swap
Sterilisation
D
Treasury
A
Economy
Central Bank
B C
Notes: It is assumed that there is excess liquidity in the economy (say K trillion);
Treasury/Ministry of Finance creates new currency ($X billion) at A; assume
K > X; central bank creates new currency ($X billion) at C; Treasury/Ministry of
Finance and the central bank swap the two currency tranches, by a single
electronic transaction; at the central bank, B is a perpetual asset, while at the
Treasury/Ministry of Finance, A is a perpetual liability; Treasury/Ministry of
Finance finances the budget deficit with central-bank created currency that is,
at a later time, sterilised through sales of government bonds already held by the
central bank
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Unlike “quantitative easing”, if the increased supply of US dollars (created by
the US Treasury) is used to effectively ?nance additional ?scal stimulus in the USA,
there would be few, if any, adverse side-effects. Under Models 1 and 2, there would be
little likelihood of long-term interest rates and the exchange rate falling and, therefore,
no incentive for capital out?ow and exchange rate con?icts on that account.
When the current af?ictions – excessive debt and de?cient demand – abate, then
the policy approach discussed above would be withdrawn and replaced by a more
conventional policy approach.
3. The in?ation risk
It might be argued that the proposed “?scal monetisation” approach, applied in
countries not experiencing a de?ation tendency, would lead to higher in?ation and
higher in?ationary expectations, thereby failing to achieve one of the key
aforementioned general policy objectives. This view is one that is deeply engrained in
policy-making circles, re?ected in the historical experience in South America and the
Weimar Republic (where hyper-in?ation developed), and pervades academia, laws,
economic textbooks, some central banks, the German ruling class and the public psyche.
Clearly, as Friedman and Schwartz (1963) explained, whenever a
monetary/currency authority prints excessive volumes of new money then, at some
point, rising in?ation is the natural consequence.
Friedman probably thought in terms of the direct quantitative effect of excessive
money supply on the price level.
Another related mechanism could operate through the interest rate channel. The
injection of new money through central bank bond purchases increases the money
supply and lowers interest rates. When interest rates are initially excessive, these lower
interest rates may increase aggregate demand. If and when aggregate demand expands
at a rate so fast that production and imports cannot satisfy the demand, then in?ation
develops. However, when countries have gross excess labour and underutilised capital
capacity, and are in the midst of a liquidity trap, then, in the short- to medium-term,
any new money pumped into the economy via bond purchases is largely hoarded by
commercial banks and other economic agents, and so, even with interest rates lowered,
pose no near-term in?ation threat.
Now consider a more constrained situation where the monetary/currency authority
prints new money strictly equivalent to the dollar value of a given increase in the size
of the ?scal de?cit.
In this case, to the extent that the newmoneycreation is used, say, to ?nance increased
public spending on infrastructure or the unemployed, the money creation will be broadly
matched by increased actual real expenditure and interest rates are unlikely to change.
Therefore, in?ation is, on those accounts, less likely to occur or be somehow“excessive”,
particularly in circumstances like the present, where aggregate demand is grossly
de?cient relative to “supply capacity”. As well, to the extent that the ?scal stimulus
generates increased production of goods and services via “multiplier” and “accelerator”
effects, any presumed excess liquidity will be smaller again. Indeed, if the economic
expansion generated by the increased ?scal stimulus ultimately outgrows the measured
creation of new money, then there could be no excess liquidity; no longer-term excess
in?ation to address; no (later) increase in government bonds held by private citizens and
businesses (as the central bank would not be forced to drain off excess liquidity);
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and no taxation liabilities to burden future generations of taxpayers. The method of
?nancing the de?cit (in this case, by limited monetisation), in and of itself, does not create
in?ation (Borio and Disyatat, 2009). The in?ation only arises subsequently, in cases
where the central bank keeps interest rates too low for too long.
It is likely that the above line of reasoning may not be suf?ciently persuasive to
many observers, academics and policy makers. After all, in the USA, Japan and the
Eurozone there are laws that speci?cally rule out the possibility of new money ?nanced
?scal de?cits, because of in?ation concerns.
However, let us tease out the possibilities a little further to better re?ect current
circumstances.
The independent central banks currently hold large stocks of government bonds on
their balance sheets due to “quantitative easing” in the USA and Japan, and defensive
bond purchases in the Eurozone. These bond holdings will, sooner or later, need to be
unwound to, inter alia, restore “normal” rates of interest and remove risk from central
bank balance sheets. These bonds could, at any time, be sold into the secondary market
to withdraw money from the economy. In the USA, for example, the central bank holds
about $US1.4 trillion worth of government securities.
If new money ($X million) was used to ?nance increased public expenditure
(of $X million) and, at the very same time or within, say, a two-year period, bonds of
equivalent value ($X million) were sold by the central bank into the secondary market,
then the overall net increase in the money supply would be zero. Consequently, under
these sterilisation circumstances there could be, ceteris paribus, no possibility of an
increase in in?ation arising from the proposed plan. In the case of the Eurozone, the
average in?ation objective (currently sought by the “one-size-?ts-all” monetary policy)
could still be achieved.
It might be thought that there is a risk with full neutralisation of the money supply
increase (suggested in the last paragraph), in that there could, over time, be insuf?cient
liquidity in the economy to support the economic stimulus. This could be the case if,
initially, there was no excess liquidity in the system. To the extent that this would be
the case, the velocity of circulation may increase to work to ?ll the gap. Otherwise, the
degree of neutralisation may need to be less than 100 per cent, possibly zero.
However, this is unlikely to be the case in countries ( Japan, USA and the UK) that
have engaged in “quantitative easing” policies. For example, in the USA there is
$1.4 trillion sitting in unproductive commercial bank reserve accounts held at the
central bank. There is no shortage of liquidity in the US ?nancial and business
systems, and, therefore, 100 per cent sterilisation (of the new money creation) might be
appropriate. Such sterilisation would start to undo the excesses (the build up in
reserves and central bank bond holdings) created by “quantitative easing” policies.
Striking the right balance with respect to sterilisation would, however, be an
ongoing operational monetary policy issue best left to central banks to resolve in the
normal course of business.
In summary, therefore, if an increase in new money creation is used to ?nance part
or all of a budget de?cit, and, if necessary, a quantum of money is withdrawn from the
economy via bond sales undertaken by the central bank, then in?ation would not
increase, and a ?scal stimulus could be delivered in order to lift overall economic
activity. In the cases of countries like Ireland and Japan, and potentially the USA and
Greece, where a de?ation tendency has been evident, then the new money supply
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increase could be proportionately greater (or any bond sales by the central bank could
be proportionately smaller) to address the de?ation problem.
4. Financing equivalence
It is generally believed that there is equivalence between two budget de?cit ?nancing
strategies:
(1) Strategy P. A new money ?nanced budget de?cit.
(2) Strategy Q. “Quantitative easing” plus a bond ?nanced budget de?cit.
Of course, if this equivalence is relevant then Strategy P (new money ?nancing of the
budget de?cit) might be regarded as redundant. However, the economic plan proposed
in this article involves not a central bank creation of new money (which is exchanged
for new government bonds), but the effective creation of new money by the Ministry of
Finance. Where the Ministry of Finance creates new currency there is no ?nancing
equivalence, as there is no increase in “current” public debt under Strategy P whereas
there is under Strategy Q.
On this basis, and as demonstrated, Strategy P has its own unique and precious
value added, raising the effectiveness of economic stimulus policies in circumstances of
weakening output and high and spiralling public debt.
5. Implications
As mentioned earlier, Policy B could be implemented by Model 1 or 2, both involving
Ministry of Finance new money creation.
If there is excess liquidity already in the economy, and if there are large bond
holdings on the central bank balance sheet – both conditions created by earlier
“quantitative easing” policies – then under both Models 1 and 2:
.
effective economic stimulus is delivered;
.
sterilisation ensures that in?ation will not rise; and
.
“current” public debt does not increase.
There are not endless shots left in the monetary policy armoury. This means that great
care needs to be taken so as not to ?re-off the remaining monetary policy shot in the
wrong direction. Each net creation of new money by a central bank is not costless, as
eventually, if the new money creation exceeds the needs of the real economy, it could
result in a higher rate of in?ation than is desirable, and may, therefore, need to be
withdrawn from the economy. Wasting new money creation now (as is arguably the
case with “quantitative easing”) could lead toward excessive in?ation at some point in
the future. Consequently, the opportunity cost of Policy B, “quantitative easing”,
is potentially substantial.
The approach discussed in this article – Policy B, implemented by Models 1 and 2 –
appears to have been largely overlooked, or passed-over, by of?cials during the global
?nancial crisis, and is unlikely to be currently high on the agendas of central banks, the
International Monetary Fund (IMF) or governments.
Opponents to the proposed strategy might erroneously argue that its application
in industrialised countries would undermine the central banks’ policy credibility (even
though such credibility is surely being tested by the latest round of “quantitative easing”
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and defensive bond purchases), make it harder for central banks to deliver on their
mandates (in respect of which they have arguably already fallen short in some
signi?cant respects), and remove pressure on governments and Ministries of Finance to
make hard ?scal choices (even though many governments have run large budget de?cits
in the presence of “independent” central banks).
6. Periphery countries and Japan
The application of Models 1 and 2 to periphery countries could be challenging from an
internal Eurozone political perspective, but not necessarily precluded by concept or
technical design. While the independent European Central Bank generally determines
monetary policy settings on the basis or Eurozone averages (not on the basis of the
circumstances prevailing in particular countries), if the approach discussed in this
paper were to be facilitated and adopted then the Ministries of Finance could
conceivably effectively ?nance part or all of their own budget de?cits with new money,
addressing burgeoning public debt problems at their source. The European Central
Bank’s Eurozone-wide policy interest rate settings would remain unaffected, and
average in?ation rates in the Eurozone would also be unaffected.
This approach could see continuing ?scal stimulus applied (relative to what would
otherwise occur under undesirable ?scal austerity measures) without raising
publicly-held or “current” public debt – thereby taking some pressure off the need for
deep austerity measures – and help to delay or avoid debt restructuring, sovereign debt
default, and another deeper banking crisis. Attempting to resolve a debt-crisis by only
addressing the symptoms, as is currently the case for European periphery countries –
using defensive, emergency bond purchases by the central bank and so-called “bail-out”
packages generating even more (relatively high interest) debt – seems counter-intuitive
and ultimately self-defeating. This is particularly the case when an early economic
recovery is not assured, when interest rates are relatively high and when the money
supply is growing veryslowly. On their own, current policies inEurope canbe thought of
as anever-lengthening bridge being constructed over an ever-rising tide of public debt. It
is unclear howlong the bridge will need to be, whether it will be high enough, whether it
will collapse under its own weight, or, indeed, quite how and when it will all end.
Japan will need to ?nance large infrastructure spending and welfare programs as a
consequence of earthquakes, tsunamis andnuclear power dif?culties. These requirements
arise at a time when Japan’s public debt is already at levels judged excessive by credit
rating agencies. Quite apart from its general relevance to Japan in pre-earthquake
circumstances, the application of Model 1 or 2 in current (post-earthquake) circumstances
would enable Japan to, inter alia, ?nance part or all of its nowmuch larger reconstruction
and infrastructure requirements without adding to its publicly held debt or “current”
public debt. Other sources of funds, for example, holdings of liquid foreign reserve assets,
as suggested recently by Reinhart and Reinhart (2011), may also be considered.
7. Diagrammatic illustration
Figure 2 shows the main thesis of this article using the familiar IS-LM framework.
Assume the economy is at the position represented by points A and D
1
. Assume that
the economy has high unemployment and a high level of public debt. Introduce a ?scal
stimulus equivalent to AB.
Consider three alternative budget de?cit ?nancing options:
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(1) Financing the budget de?cit by issuing new government bonds shifts the
economy to BD
2
.
(2) Financing the budget de?cit directly by central bank new money creation shifts
the economy to CD
2
.
(3) Financing the budget de?cit by Ministry of Finance new money creation shifts
the economy to CD
1
.
It can be observed that options (1) and (2) raise “current” public debt, but option (3)
leads to the highest GDP level without any increase in the level of “current” public debt.
8. The current ?scal strategy and the proposed new ?scal strategy
compared
Figure 3 shows the different future trajectories of net general government public debt
for two scenarios:
(1) Scenario C. Prospective budget de?cits are ?nanced by conventional bond sales.
(2) Scenario D. Prospective budget de?cits are ?nanced by Ministry of
Finance-created new money.
Scenario C, the dark line, represents current IMF forecasts. Scenario Dis the dashed line.
It can be seen from the illustrative projections shown in Figure 3 that for Greece,
Japan, the USA, Portugal, Spain and Ireland, the explosion in “current” public debt
(due to on-going budget de?cits) can be stopped at its source (see the horizontal dashed
line). This requires that Scenario D be implemented in each country by the monetary
Figure 2.
Financing de?cits and
public debt
Interest Rate
CBNMFBD
MFNMFBD
Current Public Debt Output
0 D
2
D
1
Y
1
i
1
IS
1
IS
2
LM
1
LM
2
i
0
Y
2
Y
3
C
B
A
BFBD
Notes: LM, liquidity preference/money supply equilibrium schedule;
IS, savings/investment schedule; BFBD, bond financed budget deficit
schedule; CBNMFBD, central bank new money financed budget deficit
schedule; MFNMFBD, Ministry of Finance new money financed budget
deficit schedule; “Current” public debt excludes the “perpetual” liability
that arises whenever new money is created; in reality BFBD and
MFNMFBD will be slightly left curving, as higher interest rates add
to debt
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Figure 3.
Bond and new money
?nanced budget de?cits
and debt
2011
2012
2013
2014
2015
2016
2012
2013 2014
2015 2016
Bond
Financed
New
Money
Financed
*
8,000.00
10,000.00
12,000.00
14,000.00
16,000.00
18,000.00
2 4 6 8 10
USA
Public debt ($US, billions)
Budget deficit as per cent of GDP
2011
2012
2013
2014
2015
2016
2012 2013
2014
2015
2016
Bond
Financed
New
Money
Financed
*
300
340
380
0 2 4 6 8
Greece
Budget deficit as per cent of GDP
Public debt (Euro, billions)
2011
2012
2013
2014
2015
2016
2012
2013
2014
2015
2016
Bond
Financed
New
Money
Financed
*
500,000
600,000
700,000
800,000
900,000
4 6 8 10 12
Japan
Budget deficit as per cent of GDP
Public debt (Yen, billions)
2011
2012
2013
2014
2015
2016
2012 2013
2014
2015 2016
Bond
Financed
New
Money
Financed
*
140
160
180
200
0 2 4 6 8 10 12
Ireland
Budget deficit as per cent of GDP
Public debt (Euro, billions)
2011
2012
2013
2014
2015
2016
2012 2013
2014 2015
2016
Bond
Financed
New
Money
Financed
*
150
170
190
210
0 2 4 6
Portugal
Budget deficit as per cent of GDP
Public debt (Euro, billions)
2011
2012
2013
2014
2015
2016
2012
2013
2014
2015
2016
Bond
Financed
New
Money
Financed
*
560
590
620
650
680
710
740
770
800
830
860
2 4 6 8
Spain
Budget deficit as per cent of GDP
Public debt (Euro, billions)
Source: IMF (2011); public debt is general government net debt; budget deficit is
general government net borrowing
Notes: Bond financed fiscal deficit; x---x new money financed fiscal deficit impact on
“current” public debt
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and ?scal authorities acting in an internally coordinated manner (and using Ministry of
Finance-created new money to ?nance the budget de?cit).
There are two reasons to believe that the net economic stimulus provided under
Scenario D would be greater than that provided under Scenario C.
First, under Scenario C, money is withdrawn from the economy (via bond sales) and
it is then reinjected in the form of the de?cit ?nance; in net terms there is no new money
(potential effective demand) injected into the economy. Under Scenario D, however, no
money is withdrawn from the economy, but new money is injected as it is used to
?nance the budget de?cit. In net terms, under Scenario D, additional new money
(potential effective demand) is added to the economic system.
Second, under Scenario C, an effect of the bond sales to the private sector is to raise
interest rates over time, which impacts adversely on aggregate demand. For countries
(for example, periphery countries) that run substantial budget de?cits and already
have relatively high levels of public debt (due to past pro?igate spending in the case of
Greece, or as a consequence of the earlier ?nancial crisis for most other countries), the
absorption of new government bonds by the private sector is likely to occur at higher
sovereign default risk premia. Public debt increases as a consequence, further raising
uncertainty. Interest rates and “current” public debt do not rise under Scenario D.
8.1 Summary of alternative policy options
Assume two problems occur simultaneously:
(1) de?cient private demand; and
(2) high and spiralling “current” public debt.
Assume also that an acceptable policy response should not result in rates of in?ation
higher than those currently regarded as acceptable by central banks.
Macroeconomic policy responses include.
Option (1): Conventional bond-?nanced budget de?cit. This option addresses
problem (1), but adds to problem (2).
Option (2): “Quantitative easing”. This option is largely ineffective in addressing
problem (1). This option does not increase “current” public debt, but the new money
creation increases “perpetual” debt on the central bank’s balance sheet.
One could consider Options (1) and (2) combined, an approach that has been applied
in Japan and the USA. Demand would increase due to ?scal stimulus, but “current”
public debt also increases.
Option (3): The central bank creates new money to ?nance the budget de?cit. This
option addresses problem (1), but adds to problem (2). As well, due to new money
creation, this option adds a “perpetual” liability and a corresponding asset to the
central bank’s balance sheet.
Option (4): Treasury/Ministry of Finance creates new money to directly ?nance the
budget de?cit. This option addresses problem (1) without adding to “current” public
debt. Due to new money creation, this option increases “perpetual” liabilities on the
government’s balance sheet.
Option (5): Fiscal austerity combined with defensive bond purchases by the central
bank and “bail-out” packages, hair-cuts, leveraging, etc. (the Eurozone solution).
Problem (1) gets worse. To the extent falling government revenues and increased
welfare expenditures raise the budget de?cit, then the debt problem also gets larger.
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“Bail-out” packages add to public debt. Option (5) also adds more risky doubtful debts
to the central bank’s balance sheet, adding to the possibility that recapitalisation will
become necessary, an event which would further add to public debt.
In summary: Option (5) is the only option that addresses problems (1) and (2)
concurrently. This option provides economic stimulus and stops “current” public debt
rising, as would otherwise occur as a consequence of the (higher) budget de?cit.
9. Conclusion
Economic policy-makers (both national and international) must always aimto get ahead
of crisis events and consider how they would respond to possible worst-case scenarios.
In the current environment, where many economies are simultaneously balancing on the
edge of a dangerous precipice, the worst-case scenario could be represented as a
self-reinforcing, deepening global depression driven by high and rising debt, rising
uncertainty, high share price volatility, rising pre-cautionary savings and contracting
consumer spending, falling new private investment, banking crises, contracting trade
?ows and past policy failures in the USA, Japan and the Eurozone.
This “debt-stagnation” scenario would be characterised by two principal,
self-reinforcing problems: ?rst, a widespread output contraction (accompanied by
price de?ation or a tendency toward price de?ation), and second, a continued
spiralling-up of public debt. This paper suggests a coordinated monetary and ?scal
policy response is required in order to be able to address both problems simultaneously.
There is substantial case for ensuring that, in the “debt-stagnation” scenario posited in
this article, programs of “quantitative easing” aimedat reducinglonger-terminterest rates
arti?cially are not repeated into the future. Such programs are of doubtful value overall,
andare very slow-acting at best, particularly when interest rates are already very lowand
while debt overhangs persist. Rather, any new money creation should be undertaken by
Ministries of Finance, and be deployed to ?nance part, or all, of the ongoing ?scal de?cits.
This approach would steer two of the largest economies away from the shoals of triple
jeopardy (Leijonhufvud, 2011), and provide other (periphery) countries (suffering from
high levels of public debt) a much needed lifeline at a time when neweconomic stimulus is
required to avoid deeper recessions, debt default and depression.
Independent central banks are currently being compromised by constraining laws
and policies that are resulting in wasted money creation or expensive asset purchases
and defensive, risky bond accumulation, and by risky bail-out operations, all of which
threaten to undermine the integrity of their balance sheets and their viability.
True, the public debt problems must be addressed at their source – but sharp ?scal
austerity must also be avoided in the deep recession/depression scenario being
considered in this paper.
Going forward then, ?scal de?cits in troubled periphery Eurozone countries could
be directly ?nanced by new money creation, rather than be ?nanced by bruised and
wary taxpayers (both in the north and the south) already paying high debt burdens.
Deeper ?scal federalisation – if that is considered desirable and politically feasible as a
longer-term instrument – may be more acceptable if it is not used as the principal
shorter-term policy tool by which the North saves the periphery from a default debacle.
In the USA and Japan, the same policy of new money de?cit ?nancing could apply,
to arrest the upward spiral of public debt, limit credit downgrades, provide stimulus
and minimise unemployment.
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Under the strictly controlled economic plan outlined in this paper the elusive and
seemingly “impossible trilogy” could be secured simultaneously:
.
the rising tide of “current” public debt due to on-going ?scal de?cits could be
stopped dead in its tracks;
.
economic stimulus could be delivered; and
.
appropriate in?ation outcomes could be secured.
Obviously, given the scale of the existing public debt problems in some countries, the
proposal in this paper could not be expected to undo all debt problems. While economic
growth remains below a critical rate, the existing interest burden will exceed additional
tax revenues, and public debt will rise further. That said, the proposal in this article
provides an important step forward in the right direction.
Beyond the short-term, it will be essential that medium to longer-term ?scal
consolidation resumes, that structural de?cits be unwound, and that large-scale
structural reforms be implemented. Clearer, more uniform and more policy relevant
functional de?nitions of public debt and related statistical aggregates may need to be
developed, and agreed internationally, to guide credit rating agencies and the wider
economic policy debate.
The proposal in this paper may seem to be too radical to be justi?able. However, in
judging this question, it is necessary to compare alternatives:
.
One strategy is to try to muddle through in a defensive manner using failed,
inappropriate orthodox policy paradigms. Under this strategy, “quantitative
easing” is applied in some countries, but proves ineffective in arresting the
contraction in demand and output, and only adds further to unproductive bank
reserves, business cash positions and general hoarding. The authorities in
Europe attempt to solve underlying debt problems by deep ?scal austerity
expenditure cuts aimed initially at achieving “balanced” budgets, to be then
followed by a string of budget surpluses. However, this strategy removes the
operation of automatic stabilizers, leads to additional economic contraction and
creates revenue shortfalls. Existing interest commitments, and on-going budget
de?cits, will put further upward pressure on debt levels; the risk of banking
crises and debt default will increase; and the collapse of the Eurozone will draw
ever nearer. Throughout this process, central banks, international ?nancial
institutions, other creditors and taxpayers become further exposed to rising
“lending” risks and ever-rising debt. A renewed, deeper global ?nancial and
economic crisis may not be avoided.
.
The alternative strategy is to embrace a simple, practical, pro-active, joint
monetary and ?scal policy strategy aimed at avoiding such developments. This
strategy would immediately stop the surging levels of “current” public debt that
arise from on-going budget de?cits, and it would provide an economic stimulus
to stop output from falling further. This strategy creates a bridge, until debt
de-leveraging is completed; de?cit and debt problems are contained; banks repair
balance sheets and become adequately capitalised; and liquidity traps retreat. At
the same time, this strategy stabilises and stimulates economies, and provides a
basis to achieve the sustainable economic growth rates required to cover
on-going debt interest burdens and address rising unemployment.
Delivering
economic
stimulus
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Notes
1. In a closed economy (or where public debt is held domestically), high public debt presents a
low threat to ongoing economic growth, as taxpayer liabilities that arise upon debt service
and redemption are offset by the payments received by bondholders (Lerner, 1946). In an
open economy with a sovereign currency and a ?exible exchange rate, there is little risk of
economic collapse as public debt reaches high levels, as the authorities can always print new
money to cover debt repayments. That said, the evidence suggests that, as public debt levels
reach relatively high levels, there is an adverse impact on economic growth (Reinhart and
Rogoff, 2010). Countries with high public debt levels but without a sovereign currency are
potentially at very considerable risk, as they have no capacity to ?nance budget de?cits
without further raising public debt levels and lifting sovereign default risk (Nersisyan and
Wray, 2010).
2. This is the conclusion reached by the IMF in World Economic Outlook: Recovery, Risk and
Rebalancing (IMF, 2010). Also see Guajardo et al. (2011) who demonstrate that, on average,
a 1 per cent of GDP ?scal consolidation leads to a fall in real private consumption of
0.75 per cent within two years and a fall in real GDP of 0.62 per cent.
3. In this paper, “quantitative easing” refers to the printing of new money in order to purchase
government bonds on the secondary market or other nominated (closely substitutable)
?nancial assets.
4. In October 2010, the Bank of Japan announced a shift in the overnight rate target from
0.1 per cent to a range betweenzero and0.1 per cent – an unnecessary and inconsequential feat.
5. In October 2010, the USA central bank announced a new round of “quantitative easing”
(QE2) involving the injection of $US600 billion into the economy at a time when the nominal
ten-year Treasury bond yield was only 2.6 per cent, the lowest level in over a quarter of a
century.
6. The central bank could also print new money to purchase assets, mortgages or assets backed
by consumer loans, commercial paper, exchange-traded funds and real estate investment
trusts, etc. However, it does not seem desirable for central banks to go on acquiring and
managing “private” assets (except if that operation is judged absolutely necessary as a means
to rescue failing ?nancial institutions under “lender-of-last-resort” circumstances). These
assets contain risk, will be expensive and dif?cult to value, manage, hedge, dispose of or
unwind and could involve large losses and create additional instability. If asset accumulation
is taken too far, “moral hazard” issues arise and the stability and viability of central banks
could be put at risk. In this process, the annual returns fromthe central bank to the Ministry of
Finance could fall and, ceteris paribus, the liabilities of taxpayers could be increased.
7. See Bernanke (2002, 2003), Wolf (2008) and Corden (2010). Werner used the term
“quantitative easing” to include direct lending to the government by the central bank
(Werner, 1995). In concert with popular use and understanding of the “quantitative easing”
term, Policy B is here de?ned as a separate policy approach.
8. In the US Government spending increased from 16 per cent of GDP in 1939 to 48 per cent of
GDP in 1944. In turn, the US unemployment rate fell from 17 per cent in 1939 to 1.2 per cent
in 1944 (Margo, 1993; Gordon and Krenn, 2010). In Europe, the “Marshall Plan” illustrated
the effectiveness of economic stimulus policies. More recently, during the global economic
recession in 2008/2009, successful substantial counter-cyclical ?scal expansions were
undertaken by China, Australia, Canada, Korea, Mexico and some other countries. In the
USA, a recent study found that the average response of total consumption expenditures has
been about 50-90 per cent of the economic stimulus payments disbursed in mid-2008 in the
quarter of receipts: (Parker et al., 2011). Recent IMF analysis points to sizeable output
multipliers, particularly if monetary policy remains accommodative (IMF, 2010a).
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References
Bernanke, B. (2002), “De?ation: making sure ‘It’ doesn’t happen here”, Remarks before the
National Economists Club, Washington, DC, November 21.
Bernanke, B. (2003), “Some thoughts on monetary policy in Japan”, Remarks before the Japan
Society of Monetary Economics, Tokyo.
Borio, C. and Disyatat, P. (2009), “Unconventional monetary policies: an appraisal”,
Working Paper No. 292, Bank of International Settlements, Basel.
Corden, M. (2010), “The theory of the ?scal stimulus: how will a debt-?nanced stimulus affect the
future”, Oxford Review of Economic Policy, Vol. 26 No. 1, pp. 38-47.
Friedman, M. and Schwartz, A. (1963), A Monetary History of the United States, 1867-1960,
Princeton University Press, New York, NY.
Gordon, R. and Krenn, R. (2010), “The end of the great depression 1939-41: policy contributions
and ?scal multipliers”, Working Paper No. 16380, National Bureau of Economic Research,
Cambridge, MA.
Guajardo, J., Leigh, D. and Pescatoru, A. (2011), “Expansionary austerity: new international
evidence”, Working Paper No. 11/158, International Monetary Fund, Washington, DC.
IMF (2010a), “Effects of ?scal stimulus in structural models”, Working Paper No. 10/73,
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IMF (2010b), World Economic Outlook: Recovery, Risk and Rebalancing, International Monetary
Fund, Washington, DC, October.
IMF (2011), World Economic Outlook Database, International Monetary Fund, Washington,
DC, September.
Keynes, M. (1936), The General Theory of Employment, Interest and Money, Macmillan, London.
Leijonhufvud, A. (2011), “Nature of an economy”, CEPR Policy Insight No. 53, February.
Lerner, A. (1946), The Economics of Control: Principles of Welfare Economics, Macmillan,
New York, NY.
Margo, R. (1993), “Employment and unemployment in the 1930s”, Journal of Economic
Perspectives, Vol. 7 No. 2, pp. 41-59.
Nersisyan, Y. and Wray, R. (2010), “Does excessive sovereign debt really hurt growth? A critique
of this time is different, by Reinhart and Rogoff”, working paper, Levy Economics
Institute, New York, NY, p. 603.
Parker, J., Soueles, N., Johnson, D. and McClennand, R. (2011), “Consumer spending and the
economic stimulus payments of 2008”, Working Paper No. 16684, National Bureau of
Economic Research, Cambridge, MA, January.
Pigou, A. (1933), The Theory of Unemployment, Macmillan, London.
Reinhart, C. and Reinhart, V. (2011), “Time to dip-into its rainy day fund”, Financial Times,
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Reinhart, C. and Rogoff, K. (2010), “Growth in a time of debt”, Working Paper No. 15639, National
Bureau of Economic Research, Cambridge, MA.
Werner, R. (1995), “Keizai Kyoshitsu: Keiki kaifuku, ryoteiki kinyu kanwa kara”, Nikkei,
September 2.
Williams, J. (2011), Unconventional Monetary Policy: Lessons from the Past Three Years,
The Federal Reserve Bank of San Francisco, San Francisco, CA.
Wolf, M. (2008), “Repairing the world’s ?nancial system”, The Futurist, January (Interview with
Patrick Tucker).
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Further reading
Hamilton, J. and Wu, C. (2011), “The effectiveness of alternative monetary policy tools in a zero
lower bound environment”, Working Paper No. 16956, National Bureau of Economic
Research, Cambridge, MA.
IMF (2010a), Japan: Article IV Consultations Staff Report, International Monetary Fund,
Washington, DC.
IMF (2010b), United States: Article IV Consultations Staff Report, International Monetary Fund,
Washington, DC.
IMF (2010c), World Economic Outlook Database, October, International Monetary Fund,
Washington, DC.
Krishnamurthy, A. and Vissing-Jorgensen, A. (2010), The Effects of QE2 on Long-term Interest
Rates, Kellogg Northwestern University, Chicago, IL.
Krugman, P. (1999), “Thinking about the liquidity trap”, Journal of the Japanese and
International Economies, Vol. 14 No. 4, pp. 221-37.
Reinhart, C. and Rogoff, K. (2008), “This time is different: a panoramic view of eight centuries of
?nancial crises”, Working Paper No. 13882, National Bureau of Economic Research,
Cambridge, MA.
About the author
Richard Wood is a long-serving Economist at the Australian Treasury. He has worked mainly on
macroeconomic and business taxation policy issues (including the taxation of innovative
?nancial instruments). He has served in Paris as Minister, Economic and Financial Affairs,
representing the Australian Treasury at the OECD and the Paris Club. Richard Wood can be
contacted at: [email protected]
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