Editor’s Note: Quantitative easing was once an obscure and unconventional monetary policy that central banks used to stimulate the economy. Central banks will buy financial assets to inject a pre-determined quantity of money into the economy. But now, quantitative easing is a far more common concept, with Christians fiercely split on its merits. Today Comment asked two of our leading economic and financial luminaries to tackle the question of quantitative easing. Here, the first in the mini-series, a Catholic perspective that is in favour. Or, skip to Jonathan Wellum’s argument against.
The Federal Reserve Bank’s policy of “quantitative easing” has been one of the more controversial monetary policies of recent memory. Texas Governor and presidential candidate Rick Perry has suggested that “quantitative easing” (QE) is treason and that “if this guy prints more money between now and the election, I don’t know what y’all would do to him in Iowa, but we would treat him pretty ugly down in Texas.”
While this might be just an example of the over-the-top rhetoric one hears during a presidential primary, there is no doubt that many political and business commentators strongly object to QE in a way that we rarely see in discussions of monetary policy. It is perfectly reasonable to argue that QE is not a good policy given current circumstances, or that it is not an effective means of stimulating the economy or promoting job creation. However, much of the opposition to QE seems to be based on the claim that QE is necessarily a bad policy, that it is the economic equivalent of what moral theologians call “intrinsic evil.” It is this view of QE I will address.
To evaluate the morality or ethics of QE, one has to first have a standard by which to benchmark one’s evaluation. In terms of a public policy, the Catholic benchmark is the common good (admittedly, a difficult concept to exactly specify). In the Catholic tradition, public policy is usually evaluated in two steps: first, a look at the ethics of the goals one is attempting to achieve; and second, evaluating the means by which these goals are pursued. For the former we use the principles of Catholic social thought, while the latter relies on public prudential judgment (distinguishing it from private prudential judgment, which does not have the common good as its main objective).
We need also to emphasize that a Catholic approach has to emphasize the historical and social context of the issue we are investigating. As Leo XIII stated: “Nothing is more useful than to look upon the world as it really is” (RN n 18). If QE violates one or more of the principles of Catholic Social Thought, then Christians must object to it as an immoral public policy (if it attacks human dignity, hurts the poor, and so on). Yet, the principles are general; often the ethics of a policy is more in its application (context and prudential judgment) than in the essence of the policy itself. (Often it seems that people object to taxes as if taxes are in themselves harmful to the common good, which is a ridiculous attitude to take. Taxes and monetary policy can be good or bad depending on the particulars of the policy).
It is helpful to start our examination with some background on the role of the Federal Reserve Bank in the U.S. economy. Contrary to what we are often told, the financial meltdown of 2008 was not a “100 year event” due to a “perfect storm” of unforeseeable and unconnected events. In fact, financial crises are a normal part of capitalism, which is to say that if you leave financial markets alone (that is, if you do not regulate them rigorously), they will periodically crash, causing harm to the general population (and not only to actual investors). Because of the frequency and severity of financial crises, the Federal Reserve Bank was created in 1913. The failure of the Fed to act effectively in the 1920s and ’30s prompted Congress to add the “dual mandate” of promoting full employment and price stability to their mission of regulating and supervising banks. The New Deal closely regulated financial markets, directing banks to make money through productive loans to business and households rather than through speculation. This period of tightly regulated financial markets (from the end of WWII to the 1970s) was free of financial crises, with the exception of England’s banking crisis in the 1970s.
During the Reagan and Thatcher Era, there was a move towards deregulating the economy in general. This deregulation move hit the financial services industry in the 1990s with the end of Glass-Steagall (which separated banks to keep from risking depositors’ money), the end of the bucket laws (gambling, now called derivates), and the increase in acceptable leverage rates from 12 to 1 to 40 to 1. This deregulation, along with the collapse of the Bretton Woods system of fixed exchange rates, shifted banking back toward speculation as a major profit centre.
Ironically, deregulation was supposed to bring greater stability as new innovations in finance (financial engineering was the popular term), we were told, allowed free markets to correctly price risk, thus eliminating uncertainty. Instead, as we all know, these policies gave us a constant stream of economic and financial crises (15-20 in the past 30 years, depending on how you count them; twice as often as the Olympics or the World Cup).
In the past, the Fed concerned itself with how fast the money supply was growing based on the belief (promoted most strongly by Milton Friedman) that inflation is caused by the money supply growing faster than the growth of GDP. The lack of any empirical connection between changes in the money supply and inflation, along with the difficulty in controlling the money supply, led the Fed to switch its focus to interest rates. Quantitative easing is seen as a return to influencing the excess reserves in banks (manipulating the money supply to either encourage borrowing or to monetize the expanding federal deficit). The reason for QE (and QE2 and possible QE3) was the lackluster economic recovery and the inability of the Federal Government to work toward reducing the unacceptably high unemployment rate, part of its dual mandate to promote high employment.
QE consists of the Fed purchasing assets from banks, thus supplying them with excess reserves, which, it is hoped, will prompt them to increase their lending and thus support job creation. (The monetary base has risen from around $820 billion in 2007 to $2.6 trillion in 2011, a substantial increase, much of this coming from the Fed increasing its balance sheet—that is, making purchases by creating money). By announcing how much they were going to buy, and by expanding the range of assets they would purchase (not only U.S. Bonds), they hoped to have a broader impact. The goal is to keep interest rates low for an extended time period, which will lower the cost of investing and make buying risk-free investments less attractive to riskier private-sector investments. This rise in the Fed balance sheet is seen as printing money, and it is the belief that printing money causes inflation that is behind the recent criticisms of Fed policy.
The argument against QE goes like this: QE will weaken the dollar and cause inflation (which, it is feared, will become runaway inflation), and this lowering of the value of the dollar is a hidden tax on everyone. The short hand for all this is the claim that QE involves printing money, and that any increase in the money supply will necessarily lead to inflation, and inflation will lower the real wealth of those who currently have money.
A Catholic analysis of the case against QE starts with the goals being pursued. The Fed is attempting to promote job creation (part of its dual mandate), and with over 20 million people unemployed in U.S., we can say this is a valid and worthy goal. The objection that QE will cause inflation and thus enact a tax on everyone has to be juxtaposed against the problem of unemployment. During the 1970 and early ’80s, economic policy was dominated by the idea of a trade-off between inflation and unemployment. When inflation rose, the Federal Reserve would raise interest rates, which would lower investment often causing recessions and increasing the unemployment rate. Some even argued that higher unemployment was a small price to pay for price stability for all.
Such an argument violates the Catholic idea of the common good, especially the CST preferential option for the poor. It is never acceptable to sacrifice the well-being of the poorest for the benefit of the well-to-do. And we should not be distracted by complaints that inflation hurts everyone, because inflation mostly hurts those who have money (as it is a lowering of the purchasing power of money), and thus it hurts the rich more than the poor. The argument that moderate inflation necessarily (or even often) leads to runaway inflation is without empirical support.
A Catholic analysis must also look at the actual effects of QE. The argument that QE expands the money supply which will cause inflation (the point behind Rick Perry’s comments) is based on a view of a monetary system that does not exist. The U.S. does not have a gold standard, or what used to be called hard money. The money supply regularly goes up and down without any anyone printing more money or destroying existing dollars. Furthermore, the recent rounds of QE have not lead to an increase in excess reserves in the banking system in such a manner that they increased their lending. In fact, banks do not need deposits or excess reserves to lend money (the big banks are actually now complaining of having to deal with deposits). If they have credit-worthy borrowers and are short reserves, they just go out and borrow what they need from the Fed or other banks. We have an elastic money supply that grows and shrinks based on demand, and while the Fed can discourage demand (by raising the price of borrowing from them or others), they are not very successful in getting people and businesses to borrow.
Money creation does not cause inflation. Inflation can be caused by many factors, one of which is when the economy is at full employment and there is an increase in purchasing power. In such a situation you have too much income chasing too few goods, but this only happens when the economy is at, or close to, full employment. With over 20 million out of work, this is not a problem we need to worry about.
The problem with the Federal Reserve Bank’s policy is not that it is trying to help the unemployed—a good thing!—but that their policy tool kit does not have any effective means for helping to create jobs in our current economic situation. In many recessions, the Fed’s lowering of interest rates would cause investment and consumer spending to increase—mostly because investment and consumer spending had declined because the Fed had previously raised interest rates. It is easy for the Fed to end a recession when it caused it in the first place.
However, these are not normal times. Unlike many previous recessions, this one was not caused by the Fed raising interest rates. I think that Ben Bernanke, Chairman of the Fed, recognizes that the Fed cannot stimulate the economy enough to reduce unemployment as he has repeatedly told Congress that monetary policy cannot bring us out of the Great Recession. Neither, I might add, will slashing environmental regulations or cutting government spending create jobs—in fact cutting government spending destroys jobs. What is needed is some means of getting the $4-5 trillion being hoarded by large corporations and the banks to be injected into the economy, preferably in a way that reduces inequality. Or the government can easily act as an employer of last resort and dramatically reduce unemployment now by directly hiring the unemployed.
Long term unemployment has permanent negative effects for many, and the costs of inaction far exceed the cost of action. But this part of society’s accumulated wealth is not being used for the common good, and the legitimacy of property always rests on it being used for the common good (and especially the poor). To paraphrase St. Basil the Great, we would be returning the excess wealth (or “coats”) to its rightful owners.