I would love to know the opinion of Duncan, Chris, Paul and all you other Keynesian-inspired economists about this from Scott Sumner
Suppose your family’s balance sheet has shrunk. How do you rebuild it? I suppose you could consume less and/or work more. Now suppose you are a country and your balance sheet has shrunk, how do you rebuild it? Wouldn’t the answer be the same?
If I faced a depleted balance sheet the last thing I would do is go on vacation, or switch from a full time job to a part time job. If anything, I’d want to start working overtime. But maybe this commonsense view is wrong. Consider the following observation from The Economist:
“And as investors’ panic recedes, so credit markets are beginning to function. This will not be enough to spur a vibrant recovery in America, where households must painfully rebuild their balance-sheets.”
I can’t quite tell what The Economist is saying here. Are they saying a vibrant economy (which I assume means full employment) would make it harder to rebuild balance sheets, or are they saying that one can’t have a vibrant economy at the same time as one tries to rebuild balance sheets? I do see how attempts to rebuild balance sheets could depress velocity, and if the central bank was foolish enough to leave the money supply unchanged then this could depress economic activity.
Does Sumner not realise that in a closed economy if everyone tries to consume less the ones who try to work more don’t have anyone tobuy their services? Surely he must.
I think the clue to his (IMHO) mis-thinking lies in the last sentence above: Sumner has an utterly unshakeable faith in the central bank to increase economic activity. Full stop. It doesn’t matter what the balance sheet distress might be, what structural problems the economy may have, what real shocks and media stress the investing and spending public might be under – no. All that you need is a central bank determined to carry out a ‘sufficient’ amount of open market operations at the highest heights of finance – and economic activity will follow.
You know, like it has followed in the UK, where we have produced £200bn or 15% more monetary base, and economic activity is still . . . falling. The neat clockwork world in which a central bank’s actions are able to shock the real economy into expecting inflation never fails in Sumnerland. No matter than your clients your suppliers your forecasters your bankers are all depressed and expecting order to fall: news that the Central Bank is determined – really determined, I tell you – to hit an NGDP target means that none of this wimpy Keynesian stuff will ever matter.
What a fine world we live in. There need never be a fall in aggregate demand, ever, no matter what gigantic turmoil hits the financial sector. Because central bank actions can always guarantee a sufficient level of aggregate demand. Celebrate.
I think his position is made clear in some of the voluminous comments below*: if you are convinced that money-pushing can produce whatever aggregate demand you want, then sure you won’t believe in Keynesian demand stimulus. Trouble is, in this country we’ve printed about 15% of national output and it has carried on falling. No doubt we could have done it with more conviction.
*You will notice few dissenting voices. This is because they tend to be pre-censored
Freethinking Economist 
Interesting, Giles (not sure which Paul you’re referring to but I’ll have a crack anyway).
No, I don’t get it either. As a non-economist , the ‘real life’ , micro-economic need for households to be in a position to ‘demand’/consume more before growth properly takes hold has always seemed an intuitive sine qua non to me, and actually one of the key arguments against public service cuts (meaning less low/middle income people in stable work) – one of the clearest anti-cuts arguments to ‘sell’ on the doorstep too, incidentally.
I may be wrong in my economics logic here, but I think this takes us back into the territory of an interchange between Duncan W and Tim W, with me hanging on the coat tails, a few months back around the validity of the IS/IM Keynesian model, and some of the Duncan did intend to do, but never had time for (v understandably),around reclaiming the Hobsonian thesis of underconsumption for the 21st century (with a Joan Robinson/Minsky slant around class and equity??).
But I may simply have got that wrong. Also seem to remember that John from Post-Keynesian Observations had some interesting views around this area (on the same comments thread?) but again memory is hazy.
So your sardonic ‘notion’ of conviction might be replaced by a more socialist notion of ‘redistrubitive’?
Over to Chris, Duncan, another Paul……
I think your interpretation is right.
The question is: how would OMO generate economic activity at a time when households are increasing their savings? There are three possibilities:
1. It deters the rebuilding of savings in the first place. If households expect faster monetary growth to lead to higher inflation, they’ll spend more now, partly to beat the price rises, partly because they will be content with higher debt, as this’ll be eroded by inflation.
2. Lower interest rates encourage capital spending.
3. Printing money depresses the exchange rate and boosts exports.
My hunch is that 2 and 3 are weak mechanisms. And 1 doesn’t seem to have worked, perhaps because households’ inflation expectations aren’t monetarist (maybe rationally so, if you believe Adam Posen as I do), or perhaps because demand expectations are depressed.
I share your scepticism about the ability of central banks to maintain demand.
A decade or two ago, I thought that we had all come to a concensus that central banks expanding money supply could enable economic expansion; but that the tension to take up the slack had to come from somewhere else. The purer montarists maintained that in almost all circumstances, the tension would be there as resultof the normal functioning of markets. Purer Keynesians (as opposed to those simply inspired by Keynes) maintained that the normal functioning of markets, if it worked at all, could rarely be relied upon to work promptly. The bulk of us pragmatists doubted that pushing on a piece of monetary string would be very effective; and noted that repeated fiscal stimulus generated more nominal expansion than real expansion.
Scott Sumner appears to have dredged a relic of the pure monetarists faith out of his sub-conscious while struggling with the thought that money fixed in balance sheets need not affect inflation. The logical policy conclusion from his thoughts would seem to be a version of helicopter money: shove the newly created money directly into economic agents’ balance sheets and all will be well. However, he shies away from that conclusion – whether because there is no way known to make the policy work; or it violates his shibboleths; remains undetermined.
Thanks for these, chaps: sometimes I think I’m the only person this side of the pond reading Prof Sumner, and reading all those “how right you are” comments at the bottom makes me feel awful lonely in being a sole voice thinking “This can’t be this easy”.
Though I think he would have a valid answer for the Bank of England’s QE failing, and it is one that I would use too: the Bank’s determination to not lose its virtue – “we honestly won’t let inflation rip, honestly . . ..” means that their effect on ordinary punters’ motivation is unlikely to be large, because as SS says monetary policy works as much by influencing the whole future path of interest rates and prices, than just the current conditions. In other words, QE is being presented as a temporary loan of £200bn that will be pulled back pretty fast and with little warning: in which case, why should I do anything but stick the money in other liquid assets?
I also think (2) is weak. Our biggest capital splurge was 1988-89, when rates were pretty high. The cost of the funds seems a pretty poor driver compared to sheer animal spirits, asset price expectations, and so on.
I’m with Chris on (1) being really weak. Suppose I had bought a house for £1m and the value had fallen by £300k, putting me £200k into negative equity. I would use every spare bit of cashflow to repay the debts to get me out of negative equity, regardless of interest rates. And I doubt very much that just because I’ve repaid debts, someone else will get the cash and have the same propensity to consume with it. Consumption falls, I’m sure.
David, I’m a pragmatist too: which is why I think QE needs some combination with Fiscal policy to really work. It needs some inkling that the Bank may be about to be mildly debauched, that some of the new cash will be actually USED, immediately, in the economy, that the Bank will not rest until growth (NGDP?) is resumed. I think that ‘in the foxhole’, faced with the immediate consequences of state actions, any finance minister would want a mixture of both policies just to make sure we don’t get 1931 all over again. It’s fine for academic scribblers to shout about just one club; the guys in control have to use every one in the bag.
Paul, my intuitions are there with yours. The households you no doubt meet in Lancs are unlikely to be going on a splurge just because of QE, are they? Money is being used to repay debts, and the money so released is not being used to consume.