Wednesday, December 23, 2009

Monetary Policy: Inflation-Deflation, Debt, Excess Reserves, Currency Volatility

The debate over the various aspects of monetary policy, how the Federal Reserve is handling the current financial crisis, and where the Fed's policies are taking us is heating up.  The Fed has allowed the banks to park excess money on deposit with the Fed to bolster reserves and this has provided the incentive to not lend.  The ECB, on the other hand, has had, for some time, an interest penalty which charges member banks for depositing excess reserves with it rather than putting those reserves to work in their respective economies by lending.

We have seen other countries taking action to protect their currencies from the weak dollar with increased central bank interest rates and capital controls to stem the build up of asset bubbles in their country and/or to protect their ability to export competitively.  China is pegging its currency to the Dollar and not allowing it to float freely.  China is trying to play both ends against the middle to their advantage.  We have had two posts on the China bubble including one with extensive links.

Edward Harrison had a post on naked capitalism dealing with currency volatility in which he argues that is all about debt control.  He has added another post on monetary and fiscal stimulus in which he argues it is really a debate on the role of government and its limitations.  In another post he has argued that the stimulus has been co-opted to protect the financial sector's status quo before the financial crisis and the monies have been "malinvested".  Paul Krugman has argued that the issues are for what purpose the debt is increased and creating the conditions by which it will be reduced.  His argument is that the causes of the deficit matter and are directly related to the efficient use of the money to create an economy that will reduce the debt more efficiently and quickly with GDP growth rather than inefficiently and over a much longer and more painful time.

Steven Keen has always been devoted to the necessity to control debt and the perils of leverage.  He recently reprinted a post by Mike Shedlock which begins with a paper by Robert Murphy that I linked to in my last Leftovers post.  Shedlocks's article concentrates on fractional reserve banking and how that approach argues that banks cannot lend because the money is really not there - it is a fictional construct.

Mark Thoma has recently written on the monetary policy with near zero interest rates and the conflict with fiscal policy and which should take the lead.  His article discusses the effect on inflation and the need for a price-level target with its reaction oriented pitfalls.  He wrote the article to explain quantitative easing to which he is basically opposed.

Bill Mitchell, the Australian anti-thesis to his fellow countryman Steve Keen, has written two articles on bank reserves.  In the first he argues that bank reserves do not expand lending and that fiscal policy is the most efficient way to create jobs.  He is very opposed to quantitative easing and is very critical of Krugman.  This article shows how economists with different beliefs can often approach the same problems with similar results for different reasons.

In Mitchell's second article, he argues that bank reserves are not inflationary.  The liquidity functions of a central bank are not intrinsic to the inflationary effect of the spending.  He addresses the excess reserve concept and the effect of near-zero interest rates on fiscal policy, relation to aggregate demand, and the necessity of government "to balance aggregate spending to match the capacity of the economy to absorb it."

In the final analysis, it comes down to central banks coordinating monetary policy with the government's fiscal policy to control inflation, provide liquidity, and directly target and control debt creation and spending with targeted lending for economic growth (like small businesses) and timely job creation.  While Larry Summers has said long term unemployment is an unavoidable component of this recovery and the Fed appears to be using unemployment to hold inflation down, the use of long term unemployment to deleverage debt and control spending  is not an acceptable fiscal policy in a republican democracy.  It will take 300,000 new jobs every month for five years to maybe get back to pre-financial crisis employment levels.  Government needs to get cracking and let Summers and Geithner go to work for Goldman Sachs (how long will it take Goldman Sachs to take the company private?).

The developing argument that lowering the minimum wage will spur employment, while the millions of dollars awarded for the short term risky behavior of investment bankers bonuses, is off limits for regulation, is corpulently corrupt.  It is the very basis of the unethical business model of an anointed elite's righteous greed.

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