As I briefly mentioned in my last blog post, the credit for Fed’s latest financial stimulus is given mainly to several theoretical monetary economists called market monetarists. This post will recapitulate their main idea and become a critique of some parts of their quarrels. Market monetarists reject the idea that central banks have lost ‘ammunition’ to stimulate the economy. They, in reality, believe that financial stimulus is the thing that can help the overall economy at this moment.
Even under the zero-lower bound (ZLB) constraints. Aggregate demand can, from a monetary perspective, be stimulated in two ways: quantitative easing (or any other way of increasing the amount of money source), and long-term signaling on easier financial policy in the future. As far as quantitative easing is concerned I agree with an integral part of their debate; current QE efforts create money for banks that aren’t being released into the real economy. It creates perfect sense for banking institutions to hoard cash and deposit-profit central banks overnight when alternative investments over low rates of interest are relatively more dangerous.
However, I don’t agree that higher sums of QE would be more beneficial to increase demand. I fail to see why this would after some threshold value induce banks to release the money back again to the real overall economy. The second favorable idea is to credibly signal term easier monetary policy long, when rates of interest are longer zero no.
The central argument is that this transmission of easier money in the future and anticipations of increasing demand will induce visitors to spend more today. This will make sense as businesses would make investments today if they would be certain that these investments would pay back in the foreseeable future. It’s the doubt of today that’s killing off their investments and hiring. So a credible indication of monetary plan would be enough to break the doubt surrounding their investment decisions.
I don’t believe that it’s this simple. First of all it requires a great deal of effort for a central bank or investment company to impact future targets. And why would the individuals respond to announcements from the central bank or investment company favorably? Does a business owner base his decisions on signals from a central bank or investment company really?
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No, he bases his decision on indicators from his local bank or investment company. So will a consumer. But that’s what this means; the central bank or investment company indirectly signs to consumers and businesses they are fighting uncertainty. The direct signal is being delivered to major investors like banks. They will be the ones who are supposed to re-start the investment routine, but banking institutions are being constrained from the regulatory perspective.
Investor confidence does have a tendency to increase after these announcements (as I’ve shown in the last post), but business self-confidence doesn’t capture up so quickly. Consumer confidence is slower to react even. The currently available data proves this (see here, here or here). And I anticipate that neither business or consumer confidence will surge after these announcements by the finish of this season.
They only way to attain a rise in confidence comes from increasing the disposable income of consumers (higher incomes through more careers and higher income, or via low-income taxes) and decreasing regulatory doubt and the tax burden for businesses. However, market monetarists still argue that the simplest way to achieve this signaling would be to target nominal GDP development. The ‘guideline of thumb’ target would be 5% (2% inflation plus 3% real GDP developments which are a potential GDP development path).