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December 31, 2008


Ralph Musgrave

I basically agree with the article “Stimulus and the Equation of Exchange”. But I’d like to express one reservation and two “asides”.

RESERVATION. As the governor of the Bank of England pointed out, there is a problem with “printing money and dishing it out to the population” (to put it crudely). This is that the monetary base forms only about 1% of all financial assets. I.e. if we doubled the monetary base, which would be an unprecedented move, and put this additional money in the hands of households, there might be no effect. But I don’t see the alternative. Perhaps, as the IMF has suggested, if the stimulus is targeted at those likely to spend it, there might be a decent effect ( see http://www.ft.com/cms/s/0/c205b394-d612-11dd-a9cc-000077b07658.html )

The B.of E. article is at http://www.banque-france.fr/gb/fondatio/telechar/king.pdf ( See p. 9 - half way down).

ASSIDE 1. Quite apart from any stimulus effect of expanding the monetary base, it might be an idea to expand it anyway, and make up for this expansion by curtailing the fractional reserve system enjoyed by private banks. The latter effectively gives private banks the right to print money, which they do big time during booms. They also abstain from doing so in recessions. This just exacerbates booms and recessions, seems to me. Anyone agree?

ASSIDE 2. On the subject of the two different forms of money, monetary base and private bank created credit, there is a long letter in the Financial Times from several leading economists which has got me baffled. They make the bizarre claim that the recession can be minimised by having private banks lend mega sums to governments!! First problem here is that private banks are near bust, aren’t they? The second is that while this wheeze increases the “money supply” in the form of bank created credit, I totally fail to see how this induces households to increase spending. Either I am mad or the above economists are. Someone please put me out of my misery. The letter is authored by Messers Congdon, Booth, Goodhart, etc and is at

Nathan Smith

Good points. Let me say first of all that "print money" is usually used with some irony in discussions of monetary economics. It can't mean merely to print more physical currency, at a time when such a large proportion of transactions use credit cards etc. Probably it would mean the Fed sending out checks to everyone, which they would deposit in their bank accounts. You could also mail out special debit cards that could be transferred to banks or used directly to buy goods wherever there are credit-card readers.

Private banks can't literally "print money," but financial intermediation is the source of the "money multiplier," by which a given monetary base (in some sense: M1 is the usual definition of the monetary base but one could argue for a narrower, or broader, definition) gives rise to some effective money supply (again, M2 is the usual definition, but one could expand, or narrow, it). Conceptually, banks cannot affect M but they do affect V. But to distinguish M and V cleanly in practice is difficult, and the usual definitions of M do not isolate the money supply, determined by government, from its velocity, influenced by banks, in such a neat fashion.

The basic function of a bank-- taking deposits, lending money-- would seem to be impossible to de-link from its effects on the money multiplier. Yes, financial intermediation can be pro-cyclical, and indeed is probably a major source of business cycles. But you can't ban it. I'm not sure whether you can "curtail" it without creating other distortions, since banks do, after all, play a real, value-creating role, allocating capital to (hopefully) its best uses. One response is to vary M counter-cyclically. Thus, if a banking crisis triggers a collapse in financial intermediation-- a fall in V-- then the Fed can increase M.

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