NGDP Targeting will not work

This comment by Tom Hickey originally appeared at The Economist

MMT proponents argue is that there is a difference between money created by fiscal deficits and money created by bank lending. When the government issues currency into non-government it does so through the Treasury directing its bank, the Fed, to credit non-government deposit accounts, e. g., to pay for fighter planes or to pay grannie’s social security. The transmission from reserves to bank deposits is direct and does not depend on bank lending. Moreover, since there is no liability corresponding to the assets created in non-government in crediting these bank accounts, deficit disbursements inject net financial assets into non-government. Conversely, bank lending nets to zero since each asset has a corresponding liability, so non-government net financial assets remain unchanged no matter how much banks lend.

The reason that NGDP targeting will not work is the flawed notion of the transmission mechanism from reserves to spendable bank deposits. When the Fed buys financial assets of whatever type, it simply increases bank reserves. The erroneous presumption about transmission is that that banks lend against reserves or lend out reserves. Neither is the case, as MMT points out. Rather, bank lend against capital based on demand from creditworthy borrowers willing to pay a rate that is profitable enough for the bank to risk it’s capital against. Increasing bank reserves does not spur banking lending and it does not affect the factors banks take into consideration in lending.

From this is simple to see why NGDP through increasing bank reserves, e.g., via QE, will not increase effective demand and spur increased investment to meet it. The transmission mechanism is bank lending, which is in abeyance, and increasing reserves will not increase it as the failure of QE has shown. Unless the Fed would buy real assets like houses instead of financial assets like MBS, it cannot not inject net financial assets into non-government, and there is no reason to expect an increase in effective demand due to increased bank reserves.The US is already at ZIRP and has been for some time. That has done nothing either. MMT predicted the failure of monetary policy — QE1 and QE2, as well as ZIRP, and QE3 will also fail unless the Fed would purchase real assets, which it is not permitted to do under current statute even under emergency powers, at least as I understand it. Time for fiscal policy to step up to the plate.

NGDP = nominal GDP
MBS = Mortgage Backed Securities
QE = Quantitative Easing
ZIRP = Zero Interest Rate Policy

Happy New Year!

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