Trickle-Up Monetary Policy?
In August 2012, a Bank of England paper, The distributional effects of asset purchases looked at the effects of quantitative easing on the British economy. The paper concluded that quantitative easing is reinflating the prices of financial assets, but that the distribution of these assets is very uneven, and so this reinflation is disproportionately benefiting the richest households: "By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds, although holdings are heavily skewed with the top 5% of households holding 40% of these assets."
The transmission mechanism of quantitative easing channels money through the financial sector by purchasing gilts, from where it is intended to trickle into the wider economy. Another Bank of England paper, What can the money data tell us about the impact of QE? describes this mechanism as follows: "A key channel through which QE affects the economy is by kick-starting a chain of transactions — ‘portfolio rebalancing’ — that reduce the cost of borrowing in capital markets and boost asset prices and nominal spending. This occurs because the ultimate (non-bank private sector) investors who sell gilts to the APF are likely to view the bank deposits they receive in exchange as a poor substitute for those gilts. As a result, they are likely to reinvest these proceeds into riskier assets that offer a higher return, such as corporate bonds and equities, causing the prices of those assets to rise and their yields to fall."
Yet data suggests that the monetary injections via asset purchases are not really trickling down, much less kickstarting strong growth. While money has flowed into stock markets and corporate debt lifting prices from the lows of 2009, real GDP growth in Britain has been deeply depressed since quantitative easing began in 2009, lending to business remains depressed, unemployment remains elevated at 7.9%, and M4 growth remains severely weak, even while being boosted directly by quantitative easing. So the wealth effect so far appears to be constrained to the financial economy (to such an extent that it may be an asset bubble rather than sustainable growth).
Is it just a matter of time before the effects of quantitative easing begin to bloom in the real economy, or is the transmission mechanism fundamentally broken? And — perhaps just as importantly — is it possible to have a policy that doesn't disproportionately benefit the richest?
In answering those questions, I want to propose a slightly radical experiment (previously suggested in various guises by such diverse economic thinkers as Steve Keen and Milton Friedman). If the financial sector is failing to transmit, why not try a different transmission mechanism — monetary policy direct to the public?
In the current system, the monetary base is expanded in two ways. The first is through asset purchases by the central bank, like quantitative easing. The second is lending at an interest rate into the banking system, which then allocates the money to the real economy through lending. Money lent into the real economy by the banks comes at a higher interest rate than money redeposited into the banking system, or borrowed from the central bank. In other words, it trickles down into the real economy at the cost of interest. This gives the banking system — and to some degree, the entire financial sector — an easy basis for profit. Over time, these advantages may be a factor in the growth in the financial sector as a percentage of the economy, and the post-1970s outgrowth in financial salaries compared to other industries, and may even be a factor in the post-1970s acceleration of income and wealth inequality.
Trickle-up monetary policy is a third means to expanding the monetary base, with the intention of avoiding favouring anyone in particular. With trickle-up monetary policy, the first recipients of new money are citizens, not banks — everyone gets an equal amount of new money — meaning that new money is available to spend debt-free, to invest, or save, or consume, or to extinguish a debt, before it is ever deposited in a bank. Nobody gets a first-mover advantage. The richest households and poorest households receive the same additional spending power, (but this equates to a far greater proportional increase to the poorest households). Once the money has been deposited in a bank, banks can lend and re-lend as normal.
It is important to emphasise that this is not the monetary policy of Zimbabwe or the Weimar Republic. The context is entirely different, and there is no element of seigniorage. Countries that suffer hyperinflation tend to be ones that have experienced some collapse in their real economy prior to the money printing. For instance, a collapse of agriculture, industrial production, resource shortages, the loss of a war, natural disasters, etc. So long as money printing is not a response to the collapse of the real economy, there are only remote hyperinflationary risks to the expansion of the monetary base.
Trickle-up monetary policy can be practiced within the current monetary system — for example, it could be employed on a small experimental scale to fight deflation at the zero-bound. If effective, it could be tested at various intensities and in pursuit of various functions, for instance, as a means to target a lower debt-to-nominal-GDP ratio, or simply as a means to hit a nominal GDP target.
Logically, trickle-up monetary policy would seem to address the problems of monetary policy disproportionately favouring the rich, and quantitative easing failing to transmit to the real economy.
However, until there are more data on how this functions in reality — what effects would there be for the banking system? What are the effects on inflation expectations? What are the effects on income distribution? What are the effects on unemployment? What are the effects on real growth? — it is difficult to say whether trickle-up monetary policy is an appropriate tool for deployment in depressionary and deflationary conditions, or indeed whether it might be appropriate in non-depressionary conditions too. Until we have more evidence it is just an interesting possibility.
Given the supposedly experimental nature of Abenomics, it is disappointing that the Bank of Japan are not experimenting with alternative transmission mechanisms.
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