Well, now that David Laidler has said it …
The best prof I ever had doing my undergrad at Western was David Laidler. I took a fourth year economic policy course with him, and learned a lot, especially a certain horror known as inflation (John Crow soon embarked on a disastrous war on inflation in the early 1990s that still sends shivers up many of our spines). Interestingly, Laidler considered himself on the left of the economics department, which tells you something about economics at Western (back then, anyway).
So I was keen to see Laidler’s take on the financial crisis and the Bank of Canada. But I did not expect this:
At this juncture, there is little point in Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney exhorting the banks to do better. Rather, the Bank of Canada needs to take the initiative in providing the financial system not with all the liquidity it wants, but with more than that. Only this will push financial institutions into becoming more aggressive lenders, as they dispose of excess cash holdings. The central bank could also enter the open market to buy assets directly from the non-bank public, furthering the goal of getting so much liquidity into the hands of households and firms that they too will increase their spending.
This is where fiscal stimulus fits in. Well designed, it can have immediate and beneficial effects on the sectors toward which it is directed; but more important for monetary policy, it must be financed by the sale of government bonds. If those bonds’ initial purchasers are in the financial system, or among the public at large, the Bank of Canada can then actively buy them up, as part of its efforts to force liquidity into the economy; a few intermediate transactions could be eliminated, while achieving the same ultimate result, were the central bank itself to be the bonds’ initial purchaser.
These recommendations will horrify anyone who believes that fiscal deficits financed by money creation are an inflationary route to ruin. So they are when the real economy is running near its capacity and financial markets are functioning normally. But when the real economy is depressed, and when deadlocked financial markets seem to be functioning normally, but in fact are providing insufficient stimulus to support a real recovery, those same policies will encourage the spending needed to restore normality.
In the early 1930s, U.S. policy makers were misled by the false signals of returning financial market normality to which a developing credit deadlock gave rise, and they let it grow into the Great Depression. In the early 1990s, the Bank of Japan made a similar mistake and failed to take advantage of the opportunities for aggressive monetary expansion provided by a fiscal stimulus program, thus helping ensure that the 1990s became a lost decade.
U.S. credit markets are now emitting similar misleading signals, but, to judge from recent announcements, the Fed has seen through them this time. So are Canadian markets, and the Bank of Canada should follow the Fed’s example. It is, after all, assigned to keep inflation at 2 per cent, and the way things are now developing, that is going to require quite an expansionary effort over the next year or so.
Wow. I mean this is crazy radical stuff that we were chatting about on this very blog a month ago. The times are moving quickly.
While I’m on monetary policy, there is an excellent overview of the changing balance sheet of the Federal Reserve over at Econobrowser. I had been thinking that the Fed was already engaged in money creation in buying or borrowing various financial assets. But apparently this expanding balance sheet is being sterilized so there has been no net money creation. Yet.