Wednesday 16 November 2011

Should the Bank of England hand out free money to everyone?

The UK economy is barely growing. To stimulate demand, should the Bank of England mail out a voucher worth fifty quid to every citizen of this fair land and tell them to go out and spend it on beer, fags and cheap Chinese electronics? It sounds like a mad idea, but is it any stranger than the Bank of England printing money to buy up goverment debt?

In a recent speech to the Council of Mortgage lenders - Charlie Bean, Deputy Governor for Monetary Policy, Bank of England - seriously discussed the voucher distribution idea:

"Several commentators have suggested that the effectiveness of quantitative easing could be enhanced by spending the newly created money on something other than government debt.

For instance, one idea that has been floated involves sending households a voucher, which could then be spent in the shops and redeemed for cash by the retailer. This may sound like a good idea, as it seems to get the money quickly into action in stimulating demand. Now, such a policy in effect combines an increase in borrowing to finance a temporary increase in income tax allowances with some conventional quantitative easing in which gilts are exchanged for claims on the Bank of England

But economic theory, as well as considerable evidence, suggests that such a temporary increase in disposable income would be likely to be very largely saved. Only households that wish to borrow, but presently cannot, would be likely to increase their spending materially. And making the voucher time-limited would do little to help, as households could always use the voucher instead of the cash they would have spent.

 In sum, this hardly seems the most effective way to add additional stimulus."

Charlie thinks that if we received some free money, we wouldn't spend it; we would save it.  On this point, he is right.  However, Charlie is actually making a deep and fundamental point about fiscal policy and its ability to influence output.  If it is true that we would save that spare note gifted from the BoE, it is also true that any temporary tax reduction would also be saved.  In fact, any attempt to to use fiscal policy to stimulate the economy by temporarily boosting disposable income is a wasted effort.

Charlie's observation about fiscal policy has further implications.  For the last four years, the UK government has issued huge amounts of debt.  Since government debt has to be paid off in the future, we all know that taxes will also have to increase in the future.  This means that our future disposable income will fall, and since we know we will be poorer, we are spend less now. So, running up large fiscal deficits actually depresses consumption.  The conclusion is the same - fiscal stimulus doesn't work.

Mr. Bean doesn't believe in fiscal stimulus but what about quantitative easing?   Printing new money doesn't create more output, it only increases the claims on a fixed amount of output.  The inevitable consequence of more money will be more inflation, which is exactly what happened after the previous round of quantitative easing.  Inflation went up, the economy barely grew, and unemployment remained constant.

Being a central banker Mr. Bean understands the inflationary implications of quantitative easing.  Nevertheless, he still thinks borrowers will respond to quantitative easing and spend more. This is because inflation erodes the real value of debt.  Inflation makes borrowers permanently better off.  However, for those on fixed incomes, and savers with bank deposits, inflation makes them permanently poorer.  So, quantitative easing is about robbing savers to placate debtors.  This is hardly a strategy for sustained economic growth.

There is only one way that the UK can recover from this crisis.  Tighten monetary policy to restore positive real interest rates.  Balance the budget and pay off government debt.  Reduce the size of the government and generate space for permanent reductions in taxes for working families. Reform the benefits system to create incentives for work rather than unemployment.  Break up monopolies, and downsize and privatize state owned banks.

This is the only way forward for the UK economy.  The question is how long will it take policy makers like Mr. Bean to realize it?


vodka drinker said...

QE - inflationary madness

davidb said...

And if we all bought petrol, vodka and fags they could have the benefit of getting almost all the money back as duty.

Anonymous said...

"And if we all bought petrol, vodka and fags they could have the benefit of getting almost all the money back as duty."

Drink the vodka, fill the bottle with petrol and ignite with fags....

..just an alternative view.

Anonymous said...

"fixed amount of output"

In what way is output "fixed"? Output (real GDP) grew during QE1, as well as the price level going up.

Anonymous said...

Free money for everyone? Preposterous! Only banks get free money don't you know?

Jim said...

And apart from all that, even if we did all go out and spend our vouchers, a good proportion of it would be on imports, so the stimulus would be lost to the UK economy. Just as the car scrappage scheme helped foreign car makers as much if not more than UK based ones.

Stan Jourdan said...

Whoa. good question, bad answer.

Please explain me : why is inflation a matter if people receive some free money ?

or more precisely : who will be the most hurt in such conditions ?

Also, when you say : "Tighten monetary policy to restore positive real interest rates." , do you realize that you are actually praising for a system in which thoses who have money will always get more "free" money? (because 97% of money is debt, charged with interest to those who hold most of the money)

And is that fair to you ?

Anonymous said...

Come on! Ricardian equivalence is discredited now. You really think any household is looking at govt debt and cutting back on spending because of future tax rises? What nonsense.

Vouchers are an interesting idea, but you need to follow through the balance sheet impacts. QE only replaces one liquid asset with another slightly more liquid one - ie an increase of broad money - but not net assets! - amongst financial institutions. Vouchers increase broad money amongst households, which is a good start, and also increase net private sector assets, which makes them even better. Make them short-duration, and they would certainly increase spending. The only problem is that you need to convince monetarists that this won't immediately lead to rampant inflation.

dearieme said...

The principle of democratic government (and perhaps all governments) is that Paul should get Peter's voucher. How do you plan to build that in?

Anonymous said...

Why stop at a paltry £50, give everyone £1million, that would kick start not only the UK economy but the fucking world economy.
New cars, new houses (outside of London that is)new tellies, new hoovers, new cookers, new washing machines, new tumble driers, new hair cuts, new lamb chops, new potatoes. the list is endless - until your £1million is spent that is.

Lionel said...


Indeed. Why stop at fifty quid. If a small amount of free cash will revive our fortunes, then a bigger sum will turn us into the north atlantic tiger.

Stan Jourdan said...

@Lionel : what you just don't get is that we are already doing this not with millions but with billions of $ £ or €€.

but yeah, giving all this free money to the banks is much more fair isn't it ?

Gérard Foucher said...

"if we received some free money, we wouldn't spend it; we would save it"
Ludicrous ! Would you save a tenner you found in the street ?...

Gérard Foucher said...

Inflation, inflation !... you know all about it, right ?
Do you think a basic income (i.e. free money to everyone) would all be spent or stashed ? Do you think we all need to buy more stuff or to save more ?...
What I need is more freedom !
What about investing to create new things, new services, what about learning, what about taking time to help each other, what about art, what about inventing ?
Basic income is an investment in the person and its power of creation.
More money is more freedom, more new wealth and more justice.

Anonymous said...

Get the likes of Vodaphone and the Non-Dom Billionaires to pay their dues, then we have reduced the defecit by a massive amount.
Vodaphone alone is equivalent to £200 per tax payer, add the others and it becomes £100's per month per tax payer problem solved.
Oh' but they will all move abroad, .. let them go and never darken these shores again, if they want to do business here they need to pay here, not take the profits overseas thus depriving the UK economy of the money to circulate round the system speading happiness as it goes.

Weekend Yachtsman said...

"quantitative easing is about robbing savers to placate debtors"

You got it in one.

And who is the biggest debtor of all?

Why, the State, of course.

No wonder they want more inflation - seven years of 5% halves their debts: what's not to like?

Thieving bastards.