Mayes on QE

October 11th, 2012 at 1:00 pm by David Farrar

Former Reserve Bank Chief Economist David Mayes writes in the Herald:

Printing money is usually a last resort that seriously troubled countries use to stave off collapse, and not some mysterious trick that other nations have conjured up to achieve quick riches.

I never though a so called serious political party would advocate it, since Social Credit were killed off.

New Zealand has definitely not run out of opportunities to use conventional monetary and fiscal policy if it feels the economy faces a lack of demand. So why move to the unconventional now?

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy.

And our cash rate is 2.5%

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy. If the central bank then buys longer dated bonds or other financial securities (including commercial paper or mortgages from the private sector), it may continue stimulating the economy.

Evidence from a symposium being published by The Economic Journal suggests that this is achieving a little in the United Kingdom, the United States and the Euro area.

The problem is that it only works well if people fear major inflation and rush out to buy before prices rise. Once growth re-establishes again, the central bank sells all assets and mops up the extra money before inflation gets out of hand. That of course explains why it doesn’t really work. If inflation is going to be headed off, then why buy now? Hence the weak effect.

Thus quantitative easing needs to be on a massive scale if it is to work.

And this is what worries me. The Greens proposed printing $8 billion of money to stimulate the economy. Now what would they and Labour do, if that doesn’t work? Would they say it was a silly idea, or would they say the problem is they did not print enough money? They’ll then be printing another $10b, another $20b etc.

Tags: , , ,