Last week, my good friend Curtis “Ovid” Poe posted a blog entry in which he suggested that the UK’s recent decision to print more money as a way of stimulating the economy is a fundamentally bad idea. While I personally don’t know whether or not it is actually a bad idea, Ovid’s post didn’t convince me that it wasn’t, because, as I said in a comment, “I’m quite certain that people spending more right now is a bloody good idea. So if printing more money gets people to spend more, then good, because that will encourage credit to start flowing again.”
Ovid kindly took the time to leave me an extended reply, to which I wrote a rebuttal, which LiveJournal decided was too long and rejected. So I’m posting it here on my blog, instead. It’s an interesting discussion anyway, and so deservers higher visibility than a LiveJournal comment, I think.
So, on with my reply. Ovid, you wrote:
So the town council decides to print money money as a “stimulus” and give everyone an extra $10.
I note that in the original post, you did not say that the UK government would be giving everyone a check. You just said that that they were going to print more money. These are not the same things.
First, if things get really bad the people know that this might be a one-time deal, so they may simply hoard the money and not spend it, meaning that the council has wasted resources.
Although your example is overly simplistic (necessarily so, given this medium), I agree that just giving money to people may not stimulate the economy very well. This is why Bush’s “stimulus” failed last year: A lot of middle- and upper-class families got checks for $600 per adult, and since these people weren’t having much trouble paying their bills, they just saved it. The Obama administration is trying to do it a bit differently by giving more money to poor people, who will have little choice but to spend it to alleviate debts and put food on the table, which is obviously more stimulative. Conservatives hate it, because such people don’t pay income taxes, but as they do pay payroll taxes, it’s the smart thing to do to help out responsible people in need and to stimulate the economy a bit at the same time.
So while I agree that saving a stimulus check is not stimulative, if you give the money to people who spend it, it will be more likely to be stimulative. I’ve no idea how bad off the people are in your hypothetical small town of 100.
Further, many people, seeing that money is simply being printed, now realize that the value of their currency is diluted. Where there was once $2,000, there’s now $2,200, meaning that each dollar is now worth about .91 cents (particularly when you realize that money is a proxy for labor and the amount of labor is a constant at any point in time).
I think that you’re overestimating how much people pay attention to such things. In a town of 100 people, they may notice it, but in a country like the UK, most folks won’t know that more money has been printed, and even if they did, are unlikely to think that it dilutes the value of the money they have unless there is inflation. It’s inflation that people will notice — how much their money can buy — not the quantity of pounds sterling in circulation.
But let’s say everyone has an extra $10 dollars from the council’s actions and rushes out to spend money on clothes. The two tailors now have to spin up production again, but there might be a high enough demand that they can’t supply everyone with new clothes because the tailors have limited supplies. They can try to ration the clothes to “first come, first serve”, but in practice, this isn’t what happens in economies.
Leaving aside the fact that there will be 1000s of other ways for people to spend the money, you’re assuming that there is no inventory. But I think part of the problem with the current economic situation is that companies have inventory that they’re unable to move. If people start spending more money, some of the inventory can clear out, and this will have a ripple effect, too.
In reality, the tailors would simply charge more for their clothes because of the higher demand.
In your hypothetical small town, perhaps this is true. But I think that, macroeconomically speaking, if a company can’t keep up with demand, they’ll be happy to have that problem. But again, I suspect that there are inventory build-up issues that would need to be alleviated, first.
Even if they didn’t want to, the people who want clothes first or want to ensure that they get any clothes due to limited supply (since more people are now demanding clothes) might offer more money, thus driving up prices again.
You’re assuming that the stimulative effect of the one-time distribution of money would create greater demand than there was before the recession started, which is unlikely. Given that you think that people are more likely to hoard anyway, this example of going to the other extreme (the extra money causes huge demand, more than there was before) seems gratuitously extreme. Honestly, the problem with the current stimulus plans is that they are insufficiently stimulative; no one thinks that they will be too stimulative. Indeed, as Krugman writes, it is much more dangerous to under-stimulate than to overstimulate, given the current situation.
You can’t provide unlimited amounts of cloth, so the tailors offer more money to ensure that they’re the ones who can sell or, at the very least, that they’re the ones who get the cloth first. This is a bad economy so they want to sell while they can. This knock-on effect pushes prices up throughout the economy.
Who’s talking about unlimited amounts? The distribution in your example will have a limited stimulative effect, not unlimited. This could be a problem if the government gave everyone £100M, but that wasn’t your example (or even remotely in the realm of possibility).
This is what printing money does.
You have not demonstrated that. You’ve shown an example where distributing money to people is either insufficiently stimulative, because they hoard it, or far too stimulative, because people suddenly demand virtually unlimited supplies of things. While the hoarding is more likely — especially if you give the money to people who don’t need it — the latter is a straw man.
Besides which, “printing money” != “sending stimulus checks to people.”
What would have been better for the council is to start a jobs program.
Oh, I’m in complete agreement with you on that one. Creating jobs will be the single best way to stimulate the economy. No question. My point is just that, while I don’t know enough to say whether or not printing more money will or will not be problematic, you are not convincing me that it is problematic. You may well be right, but you’re not making a convincing case as far as I’m concerned.
Also, bear in mind that these are not normal times. Normal stimulative approaches, such as lowering interest rates, just are not feasible. So governments must find other ways to be stimulative. Jobs programs are the best approach, as long as they start to approach the scope of job loss due to the recession. But I’m not surprised that governments are looking for other ways to try to stimulate the economy, even those that normally are frowned upon, such as deficit spending. In Krugman’s words, the only way out of the current crisis is for the government to “credibly promise to be irresponsible.”
Update 2010-2-15: Krugman has blogged about this.
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