Money is fungible
By Scott Sumner
Yesterday I discussed one bizarre idea that has popped up in the wake of the Great Recession. Today I’ll look at another. The newly elected leader of Britain’s Labour Party has proposed a “People’s QE”. The plan is discussed in this Financial Times piece, which inexplicably suggests the idea has some merit:
Mr McDonnell and Jeremy Corbyn, the new Labour leader, advocate a second approach: targeting QE at infrastructure projects. The central bank would buy bonds direct from the Treasury on the understanding that the funds would be used to improve housing and transport infrastructure. The timing is flawed; the Bank of England deems further QE unnecessary, and any large money creation now would risk stoking inflation. But if the idea were kept as something to implement the next time the country faces a financial crisis, it would carry quite a lot of respectability.
Some object that creating money to spend on infrastructure would undermine the central bank’s independence by forcing it to buy direct from the Treasury. Yet monetary policy has already extended well beyond its technocratic bounds into the realms of wealth distribution. QE had clear wealth effects, which could have been offset by fiscal measures. All political parties should acknowledge this. So should those of us who want free markets to retain their legitimacy.
This idea is reminiscent of the Real Bills Doctrine, popular in the early 20th century. This doctrine tried to distinguish between central bank monetary injections used for productive purposes, and those that went into “speculation”. Today economists consider this distinction to be meaningless, indeed there is no way for a central bank to control where its newly created money ends up.
Because money is fungible, it makes no difference if the central bank buys bonds that are used to fund infrastructure projects, or bonds that are used for some other purpose, say to fund military spending, or Social Security. All the money raised by a government ends up in the same pot, and it’s impossible to say whether a specific dollar you received in a Social Security check came from funds the government raised through taxes, or buy borrowing from the Chinese, or by borrowing from the Fed. Nor does it make any difference whether the bonds are bought directly from the Treasury, or in the secondary market, where transactions costs are infinitesimal.
Conceivably the plan could make a difference if it actually caused the central government to produce more infrastructure. But that’s a decision of the elected government, not the (unelected) central bank. The author notes (correctly) that the plan would lead to excessive inflation if adopted during a period where interest rates are above zero (as is likely to be the case when and if Corbyn actually took power.) Not mentioned is that QE could be combined with interest paid on reserves. But in that case the reserves would simply be another form of government borrowing, and hence the central bank would not have financed any government spending.
According to The Economist, Corbyn has already shown himself to be extraordinarily unprepared to lead a shadow cabinet. Looking at this proposal it’s easy to see why. Even the Labour MPs seem embarrassed by his incompetence during “question time.” They predict Corbyn will be replaced before the next election, to prevent a debacle for the once proud Labour Party.
PS. The FT article also claims that QE helped the rich. So what? Any policy that speeds a recovery from recession will help the rich, and the middle class, and the poor.
HT: Stephen Kirchner