Money, going out of style by Schreiber Zvi

Author:Schreiber, Zvi
Language: eng
Format: epub
Publisher: Zedess Publishing
Published: 2021-08-11T16:00:00+00:00

Monetary stimulus

Georgina reconvenes her council. “Milton has ruled out fiscal stimulus. What do we do now?”

Barbara clears her throat. “Your central banker is sitting right here. Fred should walk back to the mint and start printing money. Having more cash will help people feel wealthier and spend more. More cash will also increase available credit.”

“Barbara, economic activity is down. Prices are easing downwards. Don’t we need less cash when there are fewer transactions and lower prices? Won’t more cash just create pointless price inflation?”

“Not necessarily,” says Barbara. “Yes, economic activity is down. But there has been a big decrease in bank money, as my bank, and the other banks, tighten up credit. So I’m not sure we have too much money. Fred can print money and push interest rates down. It might cause a bit of inflation, but lower interest rates will discourage superfluous savings and encourage investment, while the extra cash will encourage spending.”

Milton sighs loudly. “You still don’t get it, do you? Perhaps injecting money into the economy will have a short-term positive effect. With more cash around, businesses might sense that they can sell their wares at a higher price and may be tempted to hire people and increase supply. But soon enough, everyone will expect prices to increase. As soon as the price increase is expected, the effect will dissipate. Then we just have price inflation without any benefit. What will you do then—print even more money and inflate prices still further? That’s insane. Any positive effect from a boost in money supply will be very short-lived. So, once again, Georgina, let the economy fix itself.”

Bill in this chapter of our story is actually a nod to William Phillips. In the 1960s, Phillips discovered the eponymous Phillips curve,[51] according to which there is always a tradeoff between inflation and unemployment. The thinking was that printing money increases inflation, but it can also trigger spending and reduce unemployment. For some years, this idea was highly influential, and people believed there was an inherent tradeoff between unemployment and inflation.

It was again Milton Friedman, and Edmund Phelps, who attacked this idea.[52] Printing money and increasing inflation, they argued, won’t reduce unemployment if the inflation is expected. True, an unexpected increase in money supply may encourage spending and production, and reduce unemployment in the short term, as businesses are temporarily fooled into thinking they can sell their goods for an increased price. But this effect will only last until inflation expectations catch up.

In effect, they were arguing for the long-term neutrality of money. If you increase the money supply, eventually prices inflate. And from the perspective of the real economy, you are back to where you started―more money and higher prices but nothing real has changed.

Friedman was arguing on theoretical grounds, but over time the empirical evidence backed him up. There is no long-term tradeoff between unemployment and inflation. In the 1970s, the West suffered from stagflation—high inflation together with high unemployment. In the 1990s and 2000s, developed economies enjoyed low inflation together with low unemployment.

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