Quantitative Easing vs. Fiscal Policy

Philip Arestis and Malcolm Sawyer

The use of “quantitative easing” (QE) has been a notable feature of monetary and financial policies conducted by many central banks (including the U.S. Federal Reserve, Bank of England and European Central Bank) in the past decade. The precise forms of QE have differed over time and country, but the central feature of QE has been the purchase of financial assets by the central bank through the issue of central bank money with the extent of those purchases set out (rather than using open market operations to maintain a target interest rate). The creation of money involved under QE has led a number of commentators to say, in effect, that the money could be used to greater effect by government (or central bank) spending. Descriptions such as “green quantitative easing” and “people’s quantitative easing” have been used, and others have invoked the idea of “helicopter money.” The term “helicopter money” invokes the story told by Friedman (1969) to illustrate the effects on the economy of an injection of dollars (dropped from a helicopter), which are then spent by the lucky recipients.

Van Lerven (2016) uses the term “public money creation” to encompass a range of proposals. (He uses the term by way of contrast with private money created by private banks as part of the loan process.) Van Lerven distinguishes three sets of proposals on how the “central bank’s ability to create money could be used.” There is, though, little reason why the use of money should be limited to these proposals. The three sets are “[1] proposals that advocate using central bank money to directly finance lending to large businesses, SMEs [small and medium enterprises], social enterprises, co-operatives and local governments; [2] proposals that advocate using money that is newly created by the central bank to finance infrastructure investment (via lending or spending); [3] proposals that advocate using newly created money to finance either a tax cut, or direct cash transfers to households, such as a one-off ‘citizen’s dividend’ (a non-repayable grant to every citizen).” A fourth set is added which offers a mix of the three just outlined. The key argument here is that if those forms of public expenditure are socially desired and desirable, then they should be undertaken using the established routes, and not reliant on the adoption of some form of “quantitative easing.”

There is a conflation here between “quantitative easing,” which involves the exchange of one set of financial assets for money, and “public money creation,” which involves the creation of money to finance expenditure. The former can have effects on asset prices, on the reserve position of the banks, etc., which may have some indirect effects on expenditure decisions. The latter involves direct expenditure, which is resource-using and income-generating. Further, money is being continuously created and destroyed—in the case of central bank money, destroyed when taxes are paid and when new bonds are sold. Whether “public money creation” would enlarge the stock of central bank money would depend on the extent to which that money creation was followed by money destruction.

The “public money creation” proposals often confuse the role of money as financing expenditure (that is, money is required to enable expenditure to be undertaken, as money is the generally accepted means of payment) and money as funding expenditure (from a balance sheet perspective, over an accounting period, source of funds equals use of funds, and an increase or decrease of money held is one source of funds). For governments, their accounts with the central bank enable them to spend money and finance their expenditure. The government expenditure then leads to crediting people’s own bank accounts. However, when people pay taxes their bank accounts are debited and correspondingly the government account at the central bank is replenished. During an accounting period, government expenditure will have been funded by tax revenues received, sale of bonds to the private sector, plus the increase in central bank money.

A major issue arises as to which institutions make and implement decisions on how much money is to be created, how much money remains in circulation, and on what the money is spent. If it is the central bank that decides how much (central bank) money is to be created within a given period, then it is deciding how much the government can spend within that period. In effect, power over the level of government expenditure shifts from the government to the central bank. If it is the central bank that decides by how much the stock of central bank money should expand (or decline) over the specified period, then it is determining the extent to which any budget deficit is money-funded, with the remainder bond-funded.

There is nothing that “public money creation” could achieve that cannot be achieved with in the way in which government expenditure and fiscal policy are undertaken at present. Public investment, as other forms of public expenditure, should be undertaken because it is deemed to be socially beneficial (which is, of course, easy to say but difficult to implement, as there will be inevitable differences in what is thought to be beneficial and how decisions should be made on what is beneficial.) Government makes decisions of expenditure plans, and those are carried through by use of the government’s account with the central bank. The amount of money created then depends on the expenditure decisions of the government. The central bank provides (initial) finance for public expenditure through the government drawing on its account with the central bank: central bank money moves from the government’s account to commercial banks (their reserves rise, with corresponding rise in their customers holding of deposits with the bank). The government’s account with the central bank is replenished through receipts of taxes and the proceeds from sale of bonds.

The use of “public money creation” could, though, have undemocratic downside if the quantity and/or the composition of public expenditure were thereby influenced by the central bank. The quantity and composition of public expenditure and the structure of taxation should be set by the government of the day through parliamentary authority. The quantity (level of or change in) public expenditure should not be in any way set by an undemocratic central bank.

References

Friedman, M (1969), The Optimum Quantity of Money and other Essays, London: Macmillan.

Van Lerven, F. (2016), Public Money Creation: Outlining the Alternatives to Quantitative Easing, London: Positive Money.

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