Steve Horwitz, one of my favorite contemporary Austrian economists – and he would be likely be one of them even if there were not such a dearth of Austrian economists to plausibly choose from — published an opinion piece in US News and World Report opposing another round of quantitative easing. His first paragraph focuses on the size of the Fed balance sheet and the (unenumerated) “new and unprecedented” powers that the Fed has accumulated, as if the size of the Fed balance sheet were somehow logically related to its accumulation of those new and unprecedented powers. But the size of the Fed’s balance sheet and the extent of the powers that it is exercising are not really the nub of Horwitz’s argument; it is the prelude to an argument that begins in the next paragraph
[P]revious rounds of quantitative easing have done little . . . to generate recovery. Of course it’s . . . possible that it’s because it wasn’t enough, but a tripling of the Fed’s balance sheet hardly seems like an insufficient attempt at monetary stimulus.
In other words, if QE hasn’t worked till now, why should we think that another round will be any more successful? But if the objection is simply that QE doesn’t matter, one might well respond that, in that case, there also doesn’t seem to be much harm in trying.
Horwitz then turns to the argument that some proponents (notably Market Monetarists) of additional QE have been making, which is that for about two decades the level of aggregate nominal spending in the economy or nominal gross domestic product (NGDP) was growing at an annual rate in the neighborhood of 5%. But since the 2008-09 downturn, the economy has fallen way below that growth path, so that the job of monetary policy is to bring the economy at least part of the way back to that path, instead of allowing it to lag farther and farther behind its former growth path. Horwitz raises the following objection to this argument.
[M]ost economic theories explaining why an insufficient money supply would lead to recession depend upon “stickiness” in prices and wages. Those same theories also indicate that, after a sufficient amount of time, people will adjust to that stickiness in prices and wages and the money supply will be sufficient again.
If that adjustment hasn’t taken place in almost four years, then perhaps it is not this “stickiness” that could perhaps be overcome by more monetary stimulus, but rather real resource misallocations that are causing delaying recovery. Those real misallocations cannot be fixed by more money. Instead, we need less regulation and more freedom for entrepreneurs to reallocate resources away from the mistakes of the boom, to where they are most valuable now.
I have three problems with this dismissal of monetary stimulus. First, Horwitz takes it as self-evident that a tripling of the Fed’s balance sheet is the equivalent of monetary stimulus. But that of course simply presumes that the demand of the public to hold the monetary base has not increased as fast or faster than the monetary base has increased. In fact, the slowdown in the growth of NGDP and inflation in the last four years suggests that the public has been more than willing to hold all the additional currency and reserves (the constituents of the monetary base) that the Fed has created. If so, there has been no effective monetary stimulus. But isn’t it unusual for the demand for the monetary base to have increased so much in so short a time? Yes, it certainly is unusual, but not unprecedented. In the Great Depression there was a huge increase in the demand to hold currency and bank reserves, and voices were then raised warning of the inflationary implications of rapidly increasing the monetary base. In retrospect, almost everyone (with the exception of some fanatical Austrian economists who tend to regard Professor Horwitz as dangerously tolerant of mainstream economics) now views the voices that were warning of inflation in the 1930s with the same astonishment as Ralph Hawtrey expressed when he compared such warnings to someone “crying fire, fire in Noah’s flood.”
Second, Horwitz may be right that most economic theories explaining why an insufficient money supply can cause unemployment rely on some form of price stickiness to explain why market price adjustments can’t do the job without monetary expansion. But price stickiness is a very vague and imprecise term covering a lot of different, and possibly conflicting, interpretations. Horwitz’s point seems to be something like the following: “OK, I’ll grant you that prices and wages don’t adjust quickly enough to restore full employment immediately, but why should four years not be enough time to get wages and prices back into proper alignment?” That objection presumes that there is a unique equilibrium structure of wages and prices, and that price adjustments move the economy, however slowly, toward that equilibrium. But that is a mistaken view of economic equilibrium, which, in the real world, depends not only on price adjustments, but on price expectations. Unless price expectations are in equilibrium, price adjustments, whether rapid or slow, cannot guarantee that economic equilibrium will be reached. The problem is that there is no economic mechanism that ensures the compatibility of the price expectations held by different economic agents, by workers and by employers. This proposition about the necessary conditions for economic equilibrium should not be surprising to Horwitz, inasmuch as it was set out about 75 years ago in a classic article by one of his (and my) heroes, F. A. Hayek. If the equilibrium set of price expectations implies an expected inflation rate over the next two to five years greater than the 1.5% it is now generally estimated to be, then the economy can’t move toward equilibrium unless inflation and inflation expectations are raised significantly.
Third, although Horwitz finds it implausible that price stickiness could account for the failure to achieve a robust recovery, he is confident that “less regulation and more freedom for entrepreneurs to reallocate resources away from the mistakes of the boom, to where they are most valuable now” would produce such a recovery, and quickly. But he offers no reason or evidence to justify a supposition that the regulatory burden is greater, and entrepreneurial freedom less, today than it was in previous recoveries. To me that seems like throwing red meat to the ideologues, not the sort of reasoned argument that I would have expected from Horwitz.
HT: Lars Christensen