With the year all but over, it seems as good a time as any to look back on the last twelve months and choose some random aspect upon which to comment. I think I will return to the topic of my first blog entry, a few months back, when I suggested that the response to The Green Party’s suggestion for quantitative easing represented a (probably deliberate) misframing of the issue. At the time I was concerned that the lazy riposte (can’t do that, it’ll cause inflation) was going to take hold, and as a result the opportunity for an important policy discussion regarding both monetary policy and fiscal restraint would be missed.
As it happened, that is pretty much as it played out. By the end of the year almost every political commentator was calling the policy proposal the Greens’ greatest misstep, and many attributed a slight softening in their polling numbers to it. Meanwhile, the Prime Minister, doing his very best end-of-year-Rhys-Darby-impression (I won’t go away until you say that you like me) made a special effort to mock the policy in his end of year address, gleefully speaking of million dollar hummus sandwiches or some such thing (forgive me for not paying full attention to the hilarious jape). As is so often the case though, Mr Key’s political antennae were well tuned: by year’s end the lobbyist’s assertion that quantitative easing would simply push up prices had become accepted fact, and all this without any sort of a discussion as to why this should be so. So, in the spirit of The Missed Political Opportunity of the Year, maybe a few words explaining why we should have taken the Greens’ suggestion far more seriously.
The laziest form of criticism goes something like this. If you put more money into circulation, then you essentially have more money chasing the same level of goods and services, and this pushes prices up. We know this is true, because it happened in Zimbabwe (or Argentina, or pre-war Germany, choose your favourite example). In logical terms, this is the equivalent of arguing that if you put air into a balloon, you will end up with greater pressure exerted across the same wall of resistance, and the result will be a burst balloon. And we know this because we once saw a person blow a balloon up and it popped. Ergo, one should never ever put air into a balloon.
The counter to the balloon argument, that we have all seen air go into balloons when they didn’t pop, works just as well in the case of quantitative easing. We can name very many times and circumstances in which easing did not lead to an inflationary crisis (In recent history, The US, The UK, Japan, The European Union, choose your favourite example).
A measured consideration then, needs to consider why extra money in circulation sometimes pushes up prices, and sometimes doesn’t. Any commentator who doesn’t at least attempt an answer to this question isn’t taking the issue seriously. Here’s my crack at it. Inflation occurs, to state the obvious, when sellers raise prices. They might do this for a number of reasons. Perhaps input prices are rising (a movement in the exchange rate perhaps, or world oil prices rising) and they need to pass on their costs. Perhaps there is less competition in the market and they can afford to increase their margins, perhaps expectations regarding future price rises inform wage settlements and other future pricing decisions.
The biggie though, with regard to more money in circulation, is demand. The oft referred to hypothetical where Governments just hand everybody wads of cash, is inflationary because as people attempt spend their money, and firms are unable to meet the sudden surge in demand, prices rise essentially as a rationing device.
So, we might argue that quantitative easing will not be inflationary in two cases. One, where the extra money in circulation doesn’t make it into the hands of consumption minded consumers, and two, where there is enough spare capacity to meet the extra demand without raising prices. In the case of The Greens’ proposal, the easing is to finance the rebuild of Christchurch, so there is undoubtedly a demand component. However, note that the smug opponents of the measure are not arguing that we don’t rebuild Christchurch, so this shouldn’t necessarily be seen as extra demand in the system. Rather, the extra demand comes about because under The Greens’ proposal the Government doesn’t have to fund the rebuild by cutting back on other services. (And maybe just pause for a moment to consider what is at stake here. Because we are all so certain quantitative easing must be inflationary, even though very often it isn’t, we are prepared to reduce spending on health programmes, on education, on the justice system, on poverty reduction programmes. At the very least, I do hope these people are thinking the issue through carefully). The Greens then are arguing that there is enough unused capacity in the system to dial back the Government’s obsession with a balanced budget without threatening runaway inflation. And I suspect they’re right.
Even if they’re not, their proposal left the Reserve Bank’s role intact, so that the policy would in effect be automatically rolled back should inflation rise. I personally think this is more conservative than it should have been, but given nobody even bothered discussing the details, it hardly matters.
Another way of looking at this is that the Government is on some level arguing the Greens’ idea is madness because it will lead to growth in the economy. I would therefore respect them a lot more if they were honest enough to say, ‘this is a bad policy because it will cause growth, job creation, a reduction in welfare dependency, increased opportunities for social investment and, possibly, inflation, and inflation is really, really bad. So let’s not do it.’ Trouble is, this is equally true of other forms of growth (or at least those not linked to increases in productive capacity) and yet this Government is maddeningly keen on growth, even if it means doubling dairy output, digging up coal and pulling out of Kyoto, so go figure.
There’s clearly much much more to it than this, but here’s not the place to develop a book length thesis (the books are out there though, plenty of them, next election vote for a politician who reads). The point I most wanted to make, in keeping with recent posts, is that sometimes a half-grasped idea takes on a theological quality, and in New Zealand’s case the religious fervour with which we embraced the war on inflation smacks of a sort of intellectual adolescence. In 2012 one party was brave enough to suggest we at least talk about the alternatives, and so we made them a laughing stock. We should feel sort of embarrassed by that, I think.