Quantitative Easing

winterspeak.com: You must be Brave or Foolish to go against UChicago econ

Finally, Robert Lucas. Lucas at least includes price and velocity — thank you for that! — but again misses the key element:

MV = Py

Given that V is going to zero (as people demand more savings) you need to increase M by a large amount so y can stay where it given that P is fixed. In the long term, P will fall and we will return to the 10 cent hamburger, but in practice the US is simply not going to be allowed to enter a 1930s style protracted and deep deflation.

The obvious solution at this point would be to talk about how we can increase M rapidly, in a way that is equally rapid to reverse! The obvious candidate, and it would be obvious to Keynes if he was alive today, would be a payroll tax holiday. It would avoid all the fiscal problems that all three economists mention, while still handling the money supply in a way that gets us to a rebalanced economy without having to do things the hard way and increase the deficit through unemployment.

Nice post.

Here, M is the money supply, V is velocity, P is the price level, and y is real GNP, so that Py is nominal GNP. If V is dropping, then Py must fall.  In one extreme with y fixed, P must fall, or deflation.  In the other, with P fixed, y must fall, or a drop in GNP.    Right now, prices and GNP are falling.  We have to crank up M, and try to get V back up, too (This is all kind of definitional, but to start the Great Depression, the Fed brought M down on purpose.  So there is some bite here.)

I think that effectively buying up new risky assets the way the Fed is doing now is probably the fastest way to crank up M. I hope that is what the lump sum tax cuts in the stimulus are trying to achieve as well.  If we can credibly commit to some future inflation, we can drop V as well.  (I recall that was Professor Krugman’s original prescription for Japan, so maybe it is not so easy to do given what happened there.  One sign it is working might be that our currency depreciates.)

But I don’t think that Professor Lucas missed the point, since he started out his talk pointing out that we can increase nominal spending by cranking up the printing presses and doing the famous helicopter drop of money, or by following Keynes and burying dollar bills in the ground to be dug up.

Cranking up M by buying more assets is the basis of the Fed’s policy of ‘quantitative easing.’  We need some faith, since monetary policy can  have long and uncertain lags.  It probably will act faster than fiscal stimulus by building infrastructure, though.

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