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Work and prosperity
16 October 2012

Monetary versus fiscal stimulus – a no score draw

Joseph Stiglitz is a Nobel laureate and a former chief economist of the World Bank. He’s a leading Keynesian and an opponent of austerity measures. At the same time, he’s highly sceptical of monetary stimulus – in particular, the practice of quantitative easing.

As he explains in a piece for Project Syndicate, this puts him on the same page as many rightwing economists, but not for the same reasons:

  • “Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September: the long awaited “QE3” (the third dose of quantitative easing by the United States Federal Reserve), and the European Central Bank’s announcement that it will purchase unlimited volumes of troubled eurozone members’ government bonds. Markets responded euphorically, with stock prices in the US, for example, reaching post-recession highs.
  • “Others, especially on the political right, worried that the latest monetary measures would fuel future inflation and encourage unbridled government spending.”

These fears seem justified. After all, inflation is what normally happens when governments turn on the printing presses. However, these are not normal times:

  • “In fact, both the critics’ fears and the optimists’ euphoria are unwarranted. With so much underutilized productive capacity today, and with immediate economic prospects so dismal, the risk of serious inflation is minimal.”

Well, OK, if the deflationary influence of all that spare capacity and economic pessimism is counteracting the potential for an inflationary spending binge, then what’s counteracting the positive potential of QE i.e. the generous supply of cheap money for productive investment?

Stiglitz has various suggestions. For instance, no amount liquidity is going to help a system that people think is about to go bust anyway:

  •  “…consider a case like Spain, where so much money has fled the banking system – and continues to flee as Europe fiddles over the implementation of a common banking system. Just adding liquidity, while continuing current austerity policies, will not reignite the Spanish economy.”

Then there’s the problem of directing the flow of all that newly created money:

  • “…in the US, the smaller banks that largely finance small and medium-size enterprises have been all but neglected. The federal government – under both President George W. Bush and Barack Obama – allocated hundreds of billions of dollars to prop up the mega-banks, while allowing hundreds of these crucially important smaller lenders to fail.”

So, for these and other reasons, Stiglitz concludes that monetary stimulus won’t work – which to, his mind, only leaves one option:

  • “…the stimulus that is needed – on both sides of the Atlantic – is a fiscal stimulus. Monetary policy has proven ineffective, and more of it is unlikely to return the economy to sustainable growth.”

But, surely, what applies to monetary stimulus also applies to fiscal stimulus? If fear of insolvency is prompting investors to pull their money from at-risk nations, then how will even more indebtedness be of any help? And, if the cash created by QE isn’t getting through to productive enterprises, the why should extra government spending be any more effective? Won’t the money just disappear into the same old black holes of waste, bail-out and patronage?

After all, it’s not as if monetary stimulus is always pursued instead of fiscal stimulus. In Britain and America, for instance, unprecedented levels of quantitative easing have gone hand-in-hand with unprecedented levels of debt-funding spending. The results should not inspire us to double-down on either bet.


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