Sidelined by years of over-promising and not delivering, the Federal Reserve may seem to be sitting this one out. Trying to stay relevant with tapering QE, the latter is no longer on anyone’s mind even as gasoline and food prices surge in a way not witnessed in decades. The fight has instead shifted to the fiscal side.
QE is the old “money printing” but after the past year Uncle Sam is the new. Even former current administration allies are throwing in the towel. Maybe those earlier 2021 “rescues” (one under Trump, the other, larger helicopter under Biden) really had been too much as the government continues to do even more.
Obama era Treasury official, well-known commentator and Economist Steven Rattner recalled this week in a New York Times opinion column how he and others tried to describe just how potent this fiscal stuff could be if wielded willy-nilly without safeguards.
“They can’t say they weren’t warned — notably by Larry Summers, a former Treasury secretary and my former boss in the Obama administration, and less notably by many others, including me. We worried that shoveling an unprecedented amount of spending into an economy already on the road to recovery would mean too much money chasing too few goods.”
There it is; the old cliché about inflation which remains as true as ever. Money chasing goods. If the Fed spent a decade without the results, and that’s what happened, then when Treasury stepped up that apparently changed the whole economic dynamic.
At least that’s what “everyone” now says. A determined government can override any pre-existing monetary condition no matter how hobbling it may have been beforehand to the (historically accurate) casting of central bank ineptness. Maybe today Economists and the public are finally willing to admit (fourteen years too late) that disinflation, at times deflation, really had been the whole problem.
But that was yesterday, last year’s news. The cat is finally out of the bag, the barndoor flung wide open for all the moneyed horses to roam free across the consumer farmyard to pay particular smelly focus on gasoline, food, and the costs to other necessities of life.
Fiscal changed everything, didn't it?
Sorry, no.
The ages-old fight between the monetary and fiscal was settled ages ago, not by conjecture or supposition but in empirical fact and documentation. Like the man said, inflation is always and everywhere a monetary phenomenon.
That man happened to be Milton Friedman. When he first uttered the truism, all the way back in 1963, he had just written (along with Anna Schwartz) his seminal work A Monetary History. Having done the exhaustive research, reading from contemporary accounts of financial and economic life, as well digging through and digging up as much data as humanly available, this was no slogan.
It wasn’t conjecture, nor some random thought bouncing around Friedman’s head as some sort of academic idea worth endlessly pursuing if only to secure scholarly sinecure.
No. This was empirical fact, ruthlessly documented, thoroughly analyzed, and dispassionately interpreted. Friedman himself recalled the lengthy process in an address he gave only seven years later, at the Harold Wincott Memorial Lecture in 1970 during the first stage of what became known as the Great Inflation.
“One swallow does not make a spring. My own belief in the greater importance of monetary policy…rests on the experience of hundreds of years and of many countries.”
In fact, the first half decade of that inflationary age proved to be yet another trial for this clash of economics (small “e”). To begin with, Friedman reminded the audience, the whole US and global economy did not fall into renewed Great Depression – as many had warned – once the tidal wave of necessary fiscal burden was lifted following the victory in World War II.
Maybe Bretton Woods and monetary stability for the first time in decades had played a deciding role.
More recent to his speech, in 1966 there had been a combination of “tight” money factors balanced against highly “expansionary” fiscal settings. To the former, “the quantity of money did not grow at all during the final nine months of the year.” The Keynesians, Friedman said, they all predicted uninterrupted nominal economic expansion into 1967 whereas the quantity of money view proposed a setback.
“So you had a nice experiment. Which was going to dominate? The tight money policy or the easy fiscal policy? The Keynesians in general argued that the easy fiscal policy was going to dominate and therefore predicted continued rapid expansion in 1967. The monetarists argued that monetary policy would dominate, and so it turned out.”
Yes, the US only nearly avoided full-on recession that year, before the panicky Federal Reserve under William McChesney Martin resumed the central bank’s typical pattern of monetary ignorance (leading into the rest of the inflationary episode).
As he said, this or the others were hardly the only examples. At issue is how fiscal policy is meant to be conducted within the constraints set forward by the monetary system. This is a problem the Japanese have been up against for the last three decades, particularly after 1997 when any semblance of fiscal restraint was indignantly cast aside in (vain) pursuit of whatever Steven Rattner is today talking about.
It's not money printing unless the money printers decide to print the money.
Even Milton Friedman has made this mistake, several times. It had been Friedman in 1997 who urged the Bank of Japan – not the government of Japan – to print high-powered money so as to shake the Japanese system out of its otherwise impenetrably deflationary nightmare. Fiscal wasn’t going to do it.
The fatal conceit isn’t fiscal vs. monetary policy, rather central bank vs. commercial bank on the latter side.
“An increased rate of monetary growth, whether produced through open-market operations or in other ways, raises the amount of cash that people and businesses have relative to other assets…All the people together cannot change the amount of cash all hold–only the monetary authorities can do that.”
This was the entirety of the Great Inflation; the monetary imbalance hadn’t been from an overactive central bank printing up its own currency, it had been a revolution in money itself urging dramatic evolution in the very nature of banking. Even Friedman would realize soon after when he suspected M1 was obsolete and the world should be further developing an M2 and beyond.
Federal Reserve officials came to see this, too, yet took almost a whole decade to get onward with M2 only to drop it realizing it wasn’t a realistic representation, either.
Thus, the great inflationary contest is between fiscal policy and actual monetary condition as determined by whatever the real economy decides is effective and useful money; excluding, to the Federal Reserve’s never-ending failure, its bank reserves.
Or the Bank of Japan’s, as in the later and also ongoing case.
The only inflationary hope, for lack of a better term, is the situation of what later came to be called “money-financed fiscal expansion.” This was in contrast to “bond-financed fiscal expansion” where governments borrowed to finance deficits, rather than in the former traditionally characterized as monetizing the debt.
But if central banks aren’t printing money given how commercial banks do instead, what would constitute “money-financed fiscal expansion?” For that answer we can turn to any number of recent examples beginning with Japan.
Like those Japanese cases, in the US over the last eighteen months it has been a repeat in exactly the same way as Friedman warned all the way back in 1970:
“If the government gets the funds by borrowing from the public, then those people who lend the funds to the government have less to spend or to lend to others. The effect of the higher government expenditures may simply be higher spending by government and those who receive government funds and lower spending by those who lend to government or by those to whom lenders would have loaned the money instead.”
This is the effect we have observed – even though, by all mainstream accounts, the Federal Reserve appears to have, whether intentional or not, monetized the rapid fiscal expansion via its latest and biggest QE yet.
From the standpoint of the commercial banking sector, as I detailed a few weeks ago, no such thing. The level of bank reserves went up, the level of indicated economic money most decidedly did not. Only the last one matters.
What Friedman was describing in that passage above is, essentially, the crowding-out effect. Even though the Fed and QE, whatnot, the monetary condition did not actually change even after the bulk of the last fiscal expansion was financed and absorbed by commercial banks at the expense of lending in the US and around the world.
Redistribution, in other words, not expansion.
The problem here, as everywhere, is the mainstream tendency to simply call everything money printing whether it is or not. QE is money printing. The Tax Cut and Jobs Act of 2017 was money printing. The Treasury helicopters were money printing. And on and on.
Thus, even if the federal government tries its hand again at more fiscal this time in the form of infrastructure, the most we’d expect is the same as the last infrastructure, the ARRA, and how it made a joke out of the term “shovel-ready.” It was hardly inflationary even though, at the time, it was characterized by all the same horrific terminology as being used again today.
Inflation is and remains always and everywhere a monetary phenomenon, not a fiscal one. The monetary system itself remains steadfast; no money has been printed, and by all useful accounts – market as well as relevant if limited data – available shadow money has been in decline all year.
Another experiment then; “On the average, the effect on prices comes about six to nine months after the effect on income and output, so the total delay between a change in monetary growth and a change in the rate of inflation averages something like 12–18 months.” So far, post-2007, that’s been just about right as these eurodollar cycles have swung from reflation to disinflation/deflation before going back again in multi-year processes.
And since eurodollar effective money is a global monetary system, we aren’t just talking about inflation or not in the United States.
Every single actual money indication has been tightening all year, this year, meaning the good news is that sometime next year we should have a lot less CPI. The far worse news is how this wouldn’t be any different than the last almost decade and a half. The government will just have piled up even more debt that commercial banks are only too willing to buy, at any price, because the money’s not there.
