Sam Bowman is a Senior Fellow, and former Executive Director, of the Adam Smith Institute.
Alex Morton is right that monetary policy matters, no matter how dull or obscure it might seem. But, in his article a week ago, he was off-base in his claims that low interest rates cause ‘rigged markets’ and that we should have had much tighter money during and after the crisis. That would have given us the same monetary policies that led to the Eurozone’s terrible past decade and that, more than anything, is what would risk a Corbyn government.
Morton mischaracterises the views of both his opponents and some of his supposed allies. Monetarists like Milton Friedman, who argued that tight monetary policy was the fundamental cause of the Great Depression and many other historical recessions, do not believe that we can “magically create growth by creating new debt and money”.
But they also recognise that while too much money presents a danger of inflation, creating too little also damages growth. Indeed, in recessions it is extremely dangerous to keep money too tight because that risks deflation, mass unemployment and economic depression. Many Austrian school economists like FA Hayek, whom Morton says he is inspired by, believe this too – Hayek was clear that keeping money too tight after a recession in one area of the economy would risk a much worse ‘secondary depression’, and that easier monetary policy was the right way to avoid that. In short, we cannot prevent economic downturns with monetary policy, but we can stop those from turning into economy-wide depressions.
Morton’s version of events is incoherent with the economic framework he says he is using. The ratio of private debt to GDP doesn’t tell you about the natural rate or what interest rates should be – this just isn’t something that any economist of any school believes. Private debt isn’t some big negative sign on your economy – for every borrower, there is a lender, and many countries that did fine after ‘08, like Australia, saw faster rises in private debt than the UK did.
Even those who do believe that money was too easy before the crisis, such as Prof Anthony J Evans, do not think that this means we should have drastically tightened policy after the crisis, or that we should drastically tighten now. In monetary policy, two wrongs don’t make a right.
Morton seems to accept the Bank of England’s findings about the impact of QE, but that the price we paid in terms of lower returns to investments made it not worth it. That’s quite a strange position. The eight per cent of GDP that QE avoided us losing is equivalent to a major multi-year recession, and pension pots would be much lower without it – the £100,000 pot he mentions would be worth much less in a QE-less world where we had endured a deep depression. His points about equities and house prices rising are neither here nor there – if these are driven by a healthier economy they’re a good thing, and though I don’t think it is very important either way, the Bank of England paper he cites says QE reduced wealth inequality. (This is debatable, but even when QE does raise inequality it’s only by reversing the process by which a recession lowers inequality.)
So if Morton’s framework is lacking, how we should think about QE and monetary policy?
The most important thing is to keep the monetary framework stable – not too much inflation, not too little, and policy that responds to changes in demand for money so we’re not thrown into deflation by factors outside the central bank’s control. Monetary policy can’t create wealth, but it can destroy it, and especially during and after recessions the danger is keeping money too tight.
That was Milton Friedman’s greatest insight in his whole Nobel-winning career, and he proved that excessively tight money was the cause of America’s worst recessions, including the Great Depression. Apart from the damage caused by the recession itself, many governments use these crises to implement higher taxes and regulation that make recovery even more difficult and make us permanently poorer.
The international evidence shows that countries that went with easier monetary policy, including quantitative easing, did well. During and after the 2008 crisis, the UK, US and Japan went with a relatively easy policy; the Eurozone went with a tight policy. The result was that the UK and US recovered relatively quickly and the Eurozone got worse and worse, crippled by the unemployment that Friedman and Hayek, among other economists, warn is caused by tight money. The most dramatic recovery of all has taken place in Japan, which has begun to grow after two decades of tight money by easing policy through an enormous programme of QE.
As well as avoiding deflation-caused unemployment, monetary policy offsets changes in government spending. The reason austerity was a success, with employment booming even as deep cuts to the size of government were made, was that the Bank of England offset the fall in government spending with easier monetary policy. This was why the Keynesians who predicted doom were wrong – they underestimated the power of monetary policy to stabilise the economy.
Things could be better with monetary rules that keep the macroeconomy stable. This emphatically is not about freezing the money supply, because the rate at which people spend money and want to have cash reserves (“velocity”) changes with confidence in the future and often very dramatically. This is one reason why the price of Bitcoin fluctuates so dramatically – the supply is fixed, so changes in demand have a huge impact on the price. At least our salaries and mortgages aren’t set in Bitcoin, or a currency managed like Bitcoin.
Our current system of flexible inflation targeting can deal with some swings in the overall economy, but many economists are now asking whether we’re targeting the right variable. Using inflation as a buffer against shocks, so that we have more of it in bad times and less of it in good times, in a system of “nominal GDP targeting” has much to recommend it – one being that it can provide reassurance to people that in recessions, even if the spending power of the pound falls, they will still be able to make their mortgage payments and their employer will still be able to pay their salaries without having to lay off large portions of their workforce.
We can’t eliminate boom and bust, but we can stop the downturns from turning into economy-wide crises. Countries like Australia managed to avoid a recession in 2008 altogether by taking an easy, Friedman approach to monetary policy, while the Eurozone did more or less what Morton recommends, driving European voters to extremists on the left and right. We made some mistakes, but on the biggest questions we got it right. Let’s learn from our successes: nothing would make a Corbyn government more likely than repeating the Eurozone’s mistakes.