Brad DeLong: It is far too soon to end expansion:
It was in 1829 that John Stuart Mill made the key intellectual leap in figuring out how to fight what he called “general gluts”: he saw that what had happened was an enormous excess demand for particular financial assets was driving an enormous excess supply of goods and services – and if you relieved the excess demand in finance you would cure the excess supply of labour. When the government relieves an excess demand for liquid money by printing up cash and swapping it out for government bonds, we call that expansionary monetary policy. When the government relieves an excess demand for bonds by printing up more Treasuries and selling them to finance its own purchases of goods and services, we call that expansionary fiscal policy. And when it prints up cash and bonds and swaps them for risky private financial assets, or when it guarantees private assets and so raises the supply of high-quality and reduces the supply of low-quality bonds, we call that banking policy.
But what happens should a government print more bonds than investors think it will dare raise future taxes to pay off? What happens when a government’s debts are no longer regarded as safe? Then policies of monetary or fiscal expansion or of banking sector asset swaps and guarantees do not boost but reduce the supply of safe assets: they move government paper into the “risky” category. We saw this in Austria in 1931 and east Asia in 1997-98 and Greece right now. Then not expansion but rather austerity, to restore confidence in the safety of government liabilities, is the best a government can do – that and cry for help from outside.
Here we have the crux: Greece, Ireland, Spain, Portugal and Italy need to be austere. But Germany, Britain, America and Japan do not. With their debts valued by the market at heights I had never thought to see in my lifetime, the best thing they can do to relieve the global depression is to engage in co-ordinated global expansion.
Expansionary fiscal, monetary and banking policy, are all called for on a titanic scale. But, the members of the pain caucus say, how will we know when we have reached the limits of expansion? How will we know when we need to stop because the next hundred billion tranche of debt will permanently and irreversibly crack market confidence in dollar or sterling or Deutschmark or yen assets? Will this shrink rather than increase the supply of high-quality financial assets the world market today so wants, and send us spiralling down?
Economists had asserted before 1829 that what we call “depressions” were impossible because excess supply of one commodity could be matched by excess demand for another: that if there were unemployed cobblers then there were desperate consumers looking for more seamstresses, and thus that the economy’s problems were never of a shortage of demand but of structural adjustment. But once Mill had pointed out that these economists had forgotten about the financial sector, the way forward was clear – if you could cure the excess demand in the financial sector. Monetarist dogma says the key excess demand in that sector is always for money – and so you can always cure depression by bringing the money supply up. The doctrine of the British economist Sir John Hicks says the key financial excess demand is for bonds, and you can cure the depression by either getting the government to borrow and spend or by raising business confidence so the private sector issues more bonds.
Followers of the US economist Hyman Minsky say the monetarists and the Hicksians (usually called Keynesians, much to the distress of many who actually knew Keynes) are sometimes right, but definitely wrong when the chips are as down as they are now. Then the key financial excess demand is for high-quality assets: safe financial places in which you can park your wealth and still be confident it will be there when you return.
After a panic, Minsky argued, boosting the money stock would fail. Cash is a high-quality asset, true, but even big proportional boosts to the economy’s cash supply are small potatoes in the total stock of assets and would not do much to satisfy the key financial excess demand. Trying to boost investment would not work either, for there was no excess demand for the risky claims to future wealth that are private bonds. The right cure, his followers argued, was the government as “lender of last resort”: increase the supply of safe assets that the private sector can hold by every means possible: printing cash, creating reserve deposits, printing up high-quality government bonds and then swapping them out into the private market in return for risky assets.
We don’t need one of expansionary monetary and fiscal and banking policy, we need all of them – until further government action begins to crack the status of the US Treasury bond as a safe asset, and further government bond issues reduce the supply of safe high-quality assets in the world economy. Has that day come? No. The US dollar is the world’s reserve currency, the US Treasury bond is the world’s reserve asset. The US has exorbitant privileges that give it freedom of action that others such as Argentina and Greece do not have. Will that day come soon? Probably not.
But trust me, we will know when the time comes to stop expansion. Financial markets will tell us. And not by whispering in a still, small voice.