Longtime blogger and Doom reader "Chuck Ponzi" was kind enough to try straightening out my confusion yesterday on the difference between fiscal and monetary issues. That was in response to my rather fuzzy commentary on the Ethan Ilzetzki presentation in under-construction Doom transcript VI.C.
His comment was sufficiently intriguing that I’d like to share it with a wider Doom audience "above the fold" (lightly edited) …
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Fiscal vs Monetary
by Chuck Ponzi
Well…
Fiscal policy in the US is controlled by the US Government. Revenues come from collection of taxes, and the expenditures come from various legislation. Basically, fiscal stimulus comes from Congress or the US Government.
In contrast, monetary policy in the US is controlled by the banking cartel known as the Federal Reserve system, aka the Fed. Monetary stimulus is a function of interest rates (overnight lending, interbank, etc). They can stimulate the economy by charging a lower percentage rate to their member banks and those banks should, in turn, lower the interest rates to their consumers (companies and people).
The term “Pushing on a String” describes what happens in monetary stimulus where the Fed lowers rates but that fails to ignite borrowing by consumers or companies. Indeed, the Fed is presently pushing money into the economy, but instead of it being taken up, the string remains slack, and banks are unable to lend.
This can have 2 possible causes:
- either banks do not see sufficient lending opportunities because all risks are bad; or,
- consumers do not see sufficient borrowing opportunities because all risks are bad.
In either case, what happened in Japan was pushing on a string because, although the rates were held low for an extended period of time, companies did not use this to invest in their own economies and therefore fuel demand which should have fueled some inflation. Instead, this created what was called the “carry-trade”, where basically people would borrow in Japan and export that borrowing elsewhere (invest somewhere else using Japan’s ultra-low rates). Some fear we are facing our own potential carry-trade here in the US. This would grow our monetary base without creating any inflation.
Chuck Ponzi
The BOJ compounded things by following a policy of absolute price stability (zero inflation) coupled with the long-term purchase of US treasuries. This forced Japan to become a nation of savers and producers, so any growth benefits of monetary “loosening” was essentially transferred to the United States. Japan may not have had huge GDP growth but the Yen appreciated, ensuring that real wages and profits (compared to the rest of the world) remained high.
Had the BOJ not been purchasing US treasuries, and had the US imposed more realistic interest rates during the first half of the 00s, any monetary loosening in Japan would’ve resulted in an increase in Japanese domestic demand (and thus consumption).
This is not to say that the BOJ is behind the current crisis, but it is certainly one of the guilty.