Paul Krugman has been a vocal advocate of QE. What’s odd about this is that QE is effectively a Monetarist policy. You expand the monetary base and that supposedly results in economic expansion, inflation, etc. Mr. Krugman has been a long-time proponent of QE because he believes it can alter expectations. Of course, being the Keynesian of all Keynesians, this is a nice case of having your cake and eating it too. In his latest missive Mr. Krugman attacks Milton Friedman for being an advocate of a policy such as QE:
David Wessel has an article asking what Milton Friedman would say about quantitative easing, and concludes that he would have been in favor. But I was struck by Friedman’s 1998 remarks about Japan, in which he basically said that increasing the monetary base would do the trick:
“The Bank of Japan can buy government bonds on the open market…” he wrote in 1998. “Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand…loans and open-market purchases. But whether they do so or not, the money supply will increase…. Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately.”
Well, they did that: staring in 2000, the BOJ nearly doubled monetary base over a period of 3 years.
And the money just sat there. Banks did not, in fact, expand loans.
In fact, Japan’s experience is a key element of the case against monetarism. Just printing notes does not work when you’re in a liquidity trap.
That’s odd. Mr. Krugman was an advocate of QE in Japan in 1999 as well:
“It is, or should be, immediately obvious from our analysis that in a direct sense the BOJ argument is quite correct. No matter how much the monetary base increases, as long as expectations are not affected it will simply be a swap of one zero-interest asset for another, with no real effects. A side implication of this analysis (see Krugman 1998) is that the central bank may literally be unable to affect broader monetary aggregates: since the volume of credit is a real variable, and like everything else will be unaffected by a swap that does not change expectations, aggregates that consist mainly of inside money that is the counterpart of credit may be as immune to monetary expansion as everything else.
But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.”
Isn’t it fair to also say that Mr. Krugman was entirely wrong in 1999? Expectations did not change in Japan. No inflation occurred. QE did nothing. It was a great big non-event. I’m a big fan of hedging your bets, but this just looks like double talk.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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