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Response to Demeter (Reply #2)

Thu Feb 14, 2013, 09:44 AM

36. “Emperor’s new clothes” moment of the Great Recession?

Wednesday night may have marked the “emperor’s new clothes” moment of the Great Recession, in which the world suddenly realizes its rulers are suffering from a delusion that doesn’t have to be humored. That delusion today is economic fatalism: the idea that nothing can be done to break the paralysis in the global economy and therefore that a “new normal” of mass unemployment and declining living standards is inevitable for years or decades to come.

That such economic fatalism is nonsensical is the key message of a truly historic speech delivered on Wednesday by Adair Turner, chairman of Britain’s Financial Services Authority and one of the most influential financial policymakers in the world. Turner argues that a virtually surefire method of stimulating economic activity exists today and that politicians and central bankers can no longer treat it as taboo: Newly created money should be handed out to the citizens or governments of countries that are mired in stagnation and such monetary financing of tax cuts or government spending should continue until economic activity revives...

/... http://blogs.reuters.com/anatole-kaletsky/2013/02/07/a-breakthrough-speech-on-monetary-policy/

The Adair Turner lecture:

<cut>... Even to mention the possibility of overt monetary finance is however close to breaking a taboo. When some comments of mine last autumn were interpreted as suggesting that OMF should be considered, some press articles argued that this would inevitably lead to hyper inflation. And in the Eurozone, the need utterly to eschew monetary finance of public debt is the absolute core of inherited Bundesbank philosophy.

To print money to finance deficits indeed has the status of a moral sin – a work of the devil – as much as a technical error. In a speech last September, Jens Weidmann, President of the Bundesbank, cited the story of Part 2 of Goethe’s Faust, in which Mephistopheles, agent of the devil, tempts the Emperor to distribute paper money, increasing spending power, writing off state debts, and fuelling an upswing which however “degenerates into inflation, destroying the monetary system” (Weidmann 2012).

And there are certainly good reasons for being very fearful of the potential to create paper or (in modern terms) electronic money. In a post-gold standard world, money is what is accepted as money: it is simply the “fiat”, the creation of the public authority. It can therefore be created in limitless nominal amounts2. But if created in excessive amounts it creates harmful inflation. And it was John Maynard Keynes who rightly argued that “there is no subtler, no surer means of overturning the existing basis of society than to debauch the currency”.

The ability of governments to create money is a potential poison and we rightly seek to limit it within tight disciplines, with independent central banks, self-denying ordinances and clear inflation rate targets. Where these devices are not in place or are not effective, the temptation that Mephistopheles presents can indeed lead to hyper-inflation – the experience of Germany in 1923 or Zimbabwe in recent years. But before you decide from that that we should always exclude the use of money financed deficits, consider the following paradox from the history of economic thought. Milton Friedman is rightly seen as a central figure in the development of free market economics and in the definition of policies required to guard against the dangers of inflation. But Friedman argued in an article in 1948 not only that government deficits should sometimes be financed with fiat money but that they should always be financed in that fashion with, he argued, no useful role for debt finance. Under his proposal, “government expenditures would be financed entirely by tax revenues or the creation of money, that is, the use of non-interest bearing securities” (EXHIBIT 1) (Friedman, 1948). And he believed that such a system of money financed deficits could provide a surer foundation for a low inflation regime than the complex procedures of debt finance and central bank open market operations which had by that time developed.

Friedman was not alone. Henry Simons, one of the founding fathers of the Chicago school of free market economics, argued in his seminal article “Rules and Authorities in Monetary Policy” that the price level should be controlled by “expanding and contracting issues of actual money” and that therefore “the monetary rules should be implemented entirely by and in turn should largely determine fiscal policy” (Simons 1936). Irving Fisher argued exactly the same (Fisher, 1936). And the idea that pure money finance is the ultimate answer to extreme deflationary dangers is a convergence point of economic thought at which there is total agreement between Friedman and Keynes. Friedman described the potential role of “helicopter money” picked up gratis from the ground (Friedman, 1969): Keynes, surprisingly, since he was not usually a puritan, wanted people to at least have to dig up the “old bottles with bank notes” (Keynes, 1936) (EXHIBIT 2). But the prescription was the same. And Ben Bernanke, current Chairman of the Federal Reserve, argued quite explicitly in 2003 that Japan should consider “a tax cut … in effect financed by money creation” (Bernanke, 2003).


When economists of the calibre of Simons, Fisher, Friedman, Keynes and Bernanke have all explicitly argued for a potential role for overt money financed deficits, and done so while believing that the effective control of inflation is central to a well run market economy – we would be unwise to dismiss this policy option out of hand. Rather, we should consider whether there are specific circumstances in which it could play a role and/or needs to play a role, and even if not, whether exploration of the theory of money and of debt helps us better understand the problems we face, problems that may be addressed by other policy tools.

In this lecture I will therefore address both appropriate targets and appropriate tools, and will consider the full range of possible tools. But I will also stress the need for us to integrate issues of financial stability and of macroeconomic policy far more effectively than mainstream economics did ahead of the crisis... <cut>

/(.pdf 48pp)... http://www.fsa.gov.uk/static/pubs/speeches/0206-at.pdf

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