Something's Missing

A second look at part of Bezemer and Gardiner's PDF from yesterday.

From the Introduction:

Thus, the study of monetary policies is not just the study of tweaking interest rates, of deciding on the rate of 'printing money', or of using taxpayers' money to bail out banks. It is the study of administering financial accounting processes on the macroeconomic level, differentiating between types of assets and liabilities.

Look at what Bezemer and Gardiner want to include in monetary policy:

• tweaking interest rates
• deciding on the rate of 'printing money'
• using taxpayers' money to bail out banks
• administering financial accounting processes on the macroeconomic level, differentiating between types of assets and liabilities

The reason I had to come back to this bit of the PDF is that something is still missing from that list.

"Tweaking interest rates." That's always what the Fed does, to get the inflation pressures where we want them, wherever that may be.

"Deciding on the rate of 'printing money'". That's the same thing.

"Using taxpayers' money to bail out banks". This is part of the response to the unusual circumstances.

And the last one, that's beyond my ken.

Bur here's the thing. For about as long as anybody has been alive, we have been using monetary restriction to fight inflation and credit-use to stimulate economic growth.

The problem is that we never change this application of policy tools. We always use tight money to fight inflation, and we always use easy credit to stimulate. This skews the playing field by reducing the quantity of money while expanding the reliance on credit, and it makes the economy's behavior increasingly unusual.

One of our basic assumptions is that printing money causes inflation. From this we come to believe that if there is inflation, there must too much money. Everyone seems to believe this. Economists and policymakers apparently believe it, for they pushed the quantity of money down relentlessly until the crisis. Even today, it is still about as low as it has ever been:

Graph #1: The Decline of Spending-Money

But fighting inflation is only half the story. Our policies also encourage credit-use, because we believe credit-use is good for growth. Again, the pressure was relentless, and nothing changed until the crisis:

Graph #2: The Rise of Credit-Use

The extreme changes shown on these graphs are results of policy. But you know, the problem goes just a little deeper than policy. What really must change are the flawed assumptions that underlie policy: the assumption that if there is inflation there must be too much money, and the assumption that credit-use is unfailingly good for growth.

It remains true that if there is inflation because there is too much spending-money, then the quantity of spending-money should be reduced. That is not true, however, if there is inflation because there is too much credit-use.

And it remains true that credit-use is good for growth when there is little credit-use. But when credit-use is already excessive, when debt is already excessive, increased credit-use is not likely to be an effective way to boost growth.

Even before policy can change, our basic assumptions must change.


So, what's missing from Dirk Bezemer's list? Let's go back to "tweaking interest rates" and stop there, and ask why we might tweak them.

Why tweak? To hinder growth and undermine inflation, or to encourage growth and end up with inflation. And what do interest rates affect? Interest rates affect the price of credit. And what is credit? Credit is the stuff that, when you use it, adds to your debt and creates future costs that will interfere with future economic performance.

What's missing from Dirk's list? Concern with the accumulation of debt.

Interest rates go up and down, up and down, up and down. But the accumulation of debt goes up, and up, and up. We ignore it at our peril.

What's missing from Dirk's list, as an essential component of monetary policy, is the need to keep watch on the balance between accumulating debt and the quantity of spending-money. Because you need spending-money to pay down debt.

Anything else you want to buy, you can put it on credit. But to pay down debt, you need spending-money.