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Archive for November 26th, 2012

Quantitative Easing or the reinvention of the wheel

Much has been said about the QE operations conducted in the US and elsewhere in the recent financial crisis. Some have claimed they constitute a true revolution in central banking; some have even gone further to suggest that it is the beginning of a new monetary policy. And, also quite many still claim that these extraordinary monetary policy measures should not be applied as they are supposed to be highly inflationary by their own nature.

Just a very quick look at the modern monetary history in Europe and in the US will reveal how wrong those views can be. On the one hand, as tested quite many times in our economic history, yes, too loose monetary policies (via QE operations or other else) will result in inflation, but only if (broad) money grows much faster than real income. So, how inflationary QE will be in the coming years cannot be assessed without making a proper monetarist analysis. Monetary expansion will have other effects, true (in part, already addressed here). On the other hand, even though under a different name, with the current QE operations we are just “inventing the wheel” or, following the Spanish saying, “discovering the Mediterranean sea”.

As quoted from Geoffrey Wood’s “The lender of last resort reconsidered” (A paper prepared for a conference in honour of Anna J Schwartz. Washington, 14-15 April 2000), in relation to the 1825 panic affecting the british banks:

There had been a substantial external drain of gold, and there was a shortage of currency.  A panic developed, and there were runs on banks.  The type of bills the Bank would normally discount soon ran out and the panic continued.  If a wave of bank failures were to be prevented, the banks would have had to borrow on the security of other types of assets. Of that change of policy Jeremiah Harman, a Director of the Bank, spoke as follows when giving evidence before a Parliamentary Committee in 1832.  The Bank had lent money “… by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances in Exchequer bills, we not only discounted outright but we made advances on the deposit of bills of exchange to an immense amount, in short by every means consistent with the safety of the Bank, and we were not on some occasions over nice”. Published in the Journal of Financial Services Research, 2000, vol. 18, issue 2, pages 203-227. See:  http://link.springer.com/article/10.1023/A%3A1026542821454.

So the Bank of England, already in the early 19th c., did conduct a truly active monetary policy to prevent the collapse of the banking system in Britain “by every possible means”; which included the purchase of stocks, public bonds, the discount of paper, … . And even most interesting,  Professor Wood (Cass Business School and University of Buckingham) provided in his work (written in 2000!) an excellent description of several successful application of the lender of last resort role of central banks that did prevent the collapse of the banking system without provoking (the supposed) hyperinflation. His work could have been taken as an excellent guide to make policy decisions from 2008 on.

The study of monetary history will do no harm to all of us at all, either academics or policy-makers. Quite the contrary!!!

Juan Castañeda

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