Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy Government PANICs! Sterling Collapses! - 19th Mar 20
Coronavirus Market Crisis - Nowhere to Hide! - 19th Mar 20
Coronavirus Most Likely GDP Economic Outcome for Q1 and Q2 2020 - 19th Mar 20
How COVID-19 Leads to 2008-Style Bank Crisis - 19th Mar 20
Coronavirus Impact on Global Economic GDP Numbers - 19th Mar 20
Bticoin Crash Big Channel Review - 19th Mar 20
Gold is Doing Its Job…Silver Will Come Back as a Safe-Haven Asset - 19th Mar 20
The Chartology of Coronavirus Deflationary Event - 18th Mar 20
Fed Slashes Rates to Zero and Introduces QE in Response to COVID-19. Will Gold Rally Now? - 18th Mar 20
Coronavirus - Nothing to Fear but Fear Itself - 18th Mar 20
The Stocks Bear Market Is Upon Us... Or Not - 18th Mar 20
US and UK Coronavirus Containment Incompetence Resulting Catastrophic Trend Trajectories - 17th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

Does Loose Monetary Policy Cause Economic Growth?

Economics / Economic Theory Sep 01, 2009 - 07:23 PM GMT

By: Frank_Shostak

Economics

Diamond Rated - Best Financial Markets Analysis ArticleAt the Federal Reserve Bank of Kansas City's annual economic symposium, held in Jackson Hole, Wyoming on August 21, 2009, Ben Bernanke expressed satisfaction with the action that his administration undertook to save the financial system. According to Bernanke,


History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation.

Furthermore, argues Bernanke,

Without these speedy and forceful actions, last October's panic would likely have continued to intensify, more major financial firms would have failed, and the entire global financial system would have been at serious risk. We cannot know for sure what the economic effects of these events would have been, but what we know about the effects of financial crises suggests that the resulting global downturn could have been extraordinarily deep and protracted. Although we have avoided the worst, difficult challenges still lie ahead.

As a result of all the swift actions argues the Fed Chairman,

Critically, fears of financial collapse have receded substantially. After contracting sharply over the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear good. Notwithstanding this noteworthy progress, critical challenges remain: Strains persist in many businesses and households continue to experience considerable difficulty gaining access to credit. Because of these and other factors, the economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels.

Most commentators are unanimous in their belief that Bernanke's Fed has prevented another Great Depression through swift monetary pumping.

Since September of last year, the yearly rate of growth of the Fed's balance sheet (the pace of money pumping) has accelerated, climbing to 152.8% by December 2008 from 3.9% in August of that year. The federal funds rate target was lowered almost to zero from 5.25% in August 2007.

Figure 1

Can Money Pumping Stimulate Economic Growth?

According to Bernanke — and most economic experts — when an economy falls into a recession, the central bank can pull it out of the slump by means of money pumping. This way of thinking implies that money pumping can somehow grow the economy.

Indeed, US historical evidence supposedly does show that loose money policy seems to work. For instance, between 1960 and 2008 it took on average about nine months before increases in money supply caused increases in the rate of growth of industrial production (See Figure 2.)

Figure 2

The question is, how is this possible? After all, if printing money can grow the economy, then why not to print plenty of it and cause massive economic growth? By doing that, central banks could have by now created an everlasting prosperity for every individual on the planet.

For most commentators, the arrival of a recession is due to unexpected events such as shocks that push the economy away from a trajectory of stable economic growth. It is held that shocks weaken the economy, i.e., lower economic growth. We suggest instead that, as a rule, a recession or an economic bust emerges in response to a decline in the rate of growth of money supply.

Typically, this takes place in response to a tighter stance of the central bank. As a result, various activities that sprang up on the back of the previously strong rate of monetary growth — usually these emerge on account of a loose monetary policy by the central bank — come under pressure.

Note that these activities cannot fund themselves independently. They survive on account of the support that the increase in the money supply provides. The increase in money diverts to them real savings from wealth-generating activities. Consequently, this weakens wealth-generating activities.

A tighter stance by the Fed and the consequent fall in the rate of growth of money undermines various false activities. This precisely is what recession is all about. Recession, then, is not a weakening in economic activity as such, but rather is the liquidation of various non-productive activities that sprang up on the back of an increase in the money supply.

Why the GDP Framework Presents a Misleading Picture

Government statisticians present economic growth in terms of monetary expenditure data, such as gross domestic product (GDP) and industrial production. These indicators are designed in line with Keynesian thinking that spending equates to income — hence, more spending leads to a higher national income and therefore to a higher economic growth.

On this logic, a tighter monetary stance by the Fed leads to slower economic growth, while increases in the money pumping produce higher economic growth. A stronger rate of growth in the money supply leads to a stronger pace of expenditure, and therefore an increase in national income. The increase in overall income in the economy leads to a higher rate of growth in terms of GDP.

We suggest that in reality the exact opposite actually takes place. Printing more money weakens the wealth generators' ability to grow the economy, while a decline in the rate of growth of the money supply strengthens their ability to grow the economy.

Once the central bank raises the pace of money pumping in order to lift the economy from a recession, it arrests the demise of various false activities. It also gives rise to new false activities. An outcome of so-called economic "growth" here is thus nothing more than the strengthening of wealth consumers and a renewed pressure on wealth generators. All of this undermines the process of wealth generation and weakens the true economic growth.

Real Savings Fund Economic Activity

Irrespective of whether an activity is productive or nonproductive, it must be funded. At any point in time, the number and the size of activities that can be undertaken is determined by the available amount of real savings. From this we can infer that the overall rate of increase in productive and nonproductive activities as a whole is set by the rate of expansion in the pool of real savings.

Observe that this runs contrary to the GDP framework, where the pace of monetary expenditure — i.e., money pumping — sets the pace of so-called economic growth. This common line of thinking, however, doesn't make much sense. After all, individuals (whether engaged in productive or nonproductive activities) must have access to real savings in order to sustain their life and well being.

Money as such cannot sustain individuals; it can only fulfill the role of the medium of exchange. According to Rothbard,

Money, per se, cannot be consumed and cannot be used directly as a producers' good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.[1]

As long as wealth producers can generate enough real wealth to support productive and nonproductive activities, loose-money policies will appear to be successful. (Observe that loose fiscal policies are similar to money policy, since they also impoverish wealth generators.)

Over time, a situation may emerge where — as a result of persistent loose monetary and fiscal policies — there are not enough wealth generators left, as they have been badly damaged by loose policies. Consequently, generated real savings are not large enough to support an increase in economic activity. Once this happens, the illusion of loose monetary policy is shattered , and real economic growth must come under pressure.

(Under such conditions, it would be difficult to show economic growth even in terms of GDP. The only reason why GDP might "grow" in such an event would be through the employment of misleading price deflators.)

The government attempt to boost the rate of growth of GDP by raising its expenditure must also fail if the supply of real savings is dwindling. After all, government activities also require real savings. (Remember, every activity, irrespective of whether it is productive or nonproductive, must be funded).

If the government persists with its aggressive stance, it will only make things much worse, as it continues to deprive funding from wealth-generating activities. Likewise, if the Fed accelerates its monetary pumping while the pool of real savings is declining, it runs the risk of severely damaging the pool of real savings even further.

It is clear, then, that those commentators who subscribe to the view that the acceleration of money pumping can fix things hold that something can be created out of nothing.

From all of this, we can deduce that there is no such thing as stimulatory policies that can grow the economy. Neither the Fed nor the government can grow the economy. All that stimulatory policies can do is to redistribute real savings from wealth producers to nonproductive activities. And these policies encourage consumption that is not supported by useful production.

The Fed's Loose Monetary Policies Have Weakened Wealth Producers

As a result of all the massive pumping by the Fed, the yearly rate of growth of our monetary measure AMS jumped from 0.7% in May 2007 to 14% by July.

Yet, despite all of this pumping, the growth momentum of industrial production remains in free fall. (Note the massive gap between the growth momentum of AMS and the growth momentum of industrial production in Figure 3.)

Figure 3

This very large gap raises the likelihood that the pool of real savings could be in trouble. If what we are saying is valid, then true, real economic growth is likely to struggle in the months ahead. (Remember, without a growing pool of real savings no economic growth is possible.)

As a rule, monetary pumping "works" through the commercial bank expansion of credit. The increase in commercial bank reserves on account of the Fed's pumping gets amplified by means of credit expansion. At present, banks are finding it more attractive to sit on the massive pile of cash reserves rather than lend them out. So far in August, bank excess reserves stood at around $700 billion — against $1.9 billion in August last year.

The banks are still in the process of trying to fix their balance sheets. They are also having trouble finding viable borrowers — i.e., wealth generators. All of this raises the likelihood that the process of wealth formation is itself in trouble.

Figure 4

Observe that if the pace of wealth generation had been rising, banks would have been very active in securing for themselves a growing slice of the expanding real wealth.

Obviously, banks could become very active by pushing lending to non-wealth-generating activities. However, this is not likely to happen soon, given that banks have already accumulated a massive amount of bad-quality assets. The latest data indicates that banks are still very tight. Year-on-year commercial bank lending has fallen by 2.8% so far in August after declining by 2.7% in July. (See Figure 5.) This was the fourth consecutive monthly decline.

Figure 5

Conclusions

At the Kansas City Fed's annual economic symposium, the chairman of the Federal Reserve expressed his satisfaction with the action that his administration undertook to save the financial system. Historical evidence supposedly supports the view that loose monetary policy can pull the US economy out of recession.

However, we suggest that so-called economic growth in response to loose policy, as reflected in terms of data such as GDP and industrial production, simply mirrors the monetary expenditure rate of growth — and not true, real economic growth. Since these indicators reflect monetary expenditure, the more that money is pumped by the Fed, the larger the so-called economic growth is going to be.

Over time, a situation can emerge where, as a result of persistent loose monetary and fiscal policies, there are not enough wealth generators left. Consequently, generated real savings are not large enough to support an increase in economic activity. In this situation, neither loose monetary policy nor loose fiscal policy can "work." We suspect that such a situation may be developing now.

Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He is chief economist of M.F. Global. Send him mail. See his article archives. Comment on the blog.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules