How quantitative easing works — or doesn’t (Part Three: “works” defined)
Whenever someone undertakes to explain “how quantitative easing works” the first question you should ponder is: how does this person define the term “works”. Remember, cyanide works, and so does aspirin — both will, for instance, cure a headache. How they work may, of course, have an impact on which you choose to treat a hangover.
To understand what is meant when we discuss how quantitative easing works (i.e., the meaning of the word works) we need to look at the role of the central bank.
In a propaganda pamphlet that would make even Orwell’s Ministry of Truth cringe, titled Quantitative Easing Explained, the anonymous flacks for the Bank of England explain the goal of quantitative easing this way:
Stable inflation promotes a healthy economy: Low and stable inflation is crucial to a thriving and prosperous economy. The Bank of England aims to keep inflation at the 2% target set by the Government. The Bank uses interest rates to control inflation. It sets an interest rate at which it lends to financial institutions – Bank Rate. That influences many other rates available to savers and borrowers, so movements in Bank Rate affect spending by companies and their customers and, over time, the rate of inflation. Changes in Bank Rate can take up to two years to have their full impact on inflation. So the Bank has to look ahead when deciding on the appropriate monetary policy. If inflation looks set to rise above target, then the Bank raises rates to slow spending and reduce inflation. Similarly, if inflation looks set to fall below 2%, it reduces Bank Rate to boost spending and inflation.
Supplying more money why it is needed: The money supply needs to keep growing at a steady rate to keep pace with the expansion of the economy, and to ensure inflation remains close to the Government’s 2% target. Money in a modern economy comprises both cash and bank deposits. Normally, the amount of money grows each year. In the past, there have been periods when money has expanded too rapidly. Too much money circulating in the economy eventually resulted in too much inflation. But if the economy weakens sharply, as it did in the final months of 2008, the problem is different. There is a risk of too little money circulating, not too much.
According to the Bank of England, the supply of currency has to be managed as the economy grows to ensure that the prices of goods rise each year by approximately the official target of 2 percent. When, as at present, the economy is severely contracting — not expanding — central bank intervention is required to keep prices from contracting as well. The primary function of the central bank, therefore, is not to keep inflation close to the official target, but to ensure that prices never fall.
However, in the present circumstances, conventional monetary policy tools have failed in this task; so the Bank of England is now trying to directly flood the economy with cash:
Same target a new tool: When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero. So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’. The Bank’s Monetary Policy Committee (MPC) meets each month to discuss economic developments and the outlook for inflation. At that meeting, the MPC votes on Bank Rate. It may also decide whether to inject money directly into the economy, and if so, how much.
So we can define the word “works” to mean that quantitative easing, if it is effective, will force you to pay more for everything you purchase. Or, to put it another way, if quantitative easing is successful, your present income will no longer be sufficient to support your material standard of living — you will be 2 percent poorer each year that Washington can achieve its target rate of 2 percent inflation.
In other words, to say quantitative easing works is actually to say YOU WILL WORK — and you work longer and harder each year, just to maintain the same standard of living. Which should be no surprise to you, since only Wall Street Bankers assume We, the Sheeple of the United States, are so dumb as to not notice that higher prices mean we must work more hours or be paid more for the hours we already work in order to buy the same amount of goods.
At the same time, successful quantitative easing implies that these increasing hours of work, and even higher pay for a given amount of work, must not result in more real goods per hour of work. The additional hours of work put in by the population must consume more of the existing output of society than it adds to it, otherwise there is no inflation.
If, for example, the productiveness of the society should increase by 4 percent in a year, the amount of work actually performed must increase by 4 percent + 2 percent or 6 percent each year to achieve the target inflation rate of 2 percent set by the central bank.
The very idea that a central bank (the big ones are the Federal Reserve Bank, the Bank of England, the European Central Bank and the Bank of Japan) would have as its mandate to actually make society less productive, to make work less productive, is so astonishingly bizarre and conflicts so radically with common sense that few people even appear to notice it. The term productivity holds such an honored position in the national economic myth, it appears patently absurd to think reducing productivity is Washington’s actual goal. Only occasionally do we get a glimpse of its effect on hours of work as seen in this snippet from Bloomberg Business Week:
If there was little surprise in much of the speech, however, [former Obama Economic Policy guru Larry] Summers did offer up one new insight into why unemployment keeps going up so sharply despite the stimulus spending. He argued that productivity has remained stronger at this point in the recession than it has in similar downturns in the past, meaning employers can get by with even fewer workers than might otherwise have been expected. Summers added that the phenomenon is not well understood. Here’s his take:
“The economic contraction has caused significant job loss. It is noteworthy, however, that the higher than forecasted job losses do not appear to be primarily the result of weaker-than- expected GDP. Rather, it appears that a given level of output is being produced with fewer people working than historical relationships would have led one to predict. In economists’ language, there is a significant residual in the Okun’s law relationship: the unemployment rate over the recession has risen about 1-to-1.5 percentage points more than would normally be attributable to the contraction in GDP.
To put the point a different way, normally in economic downturns, productivity decreases as firms keep workers employed even as the amount of work declines. This pattern of deteriorating productivity has not been a feature of the current recession. In fact, productivity has increased in this recession, as it did in the last.
One potential explanation for this phenomenon, though by no means a dispositive one, is that the greater financial pressure on firms in this recession has led them to shed cash flow commitments at an unusually rapid rate by laying off workers and leaving jobs vacant. Perhaps an expectation that the recession would be lengthy has also contributed to this behavior.”
While we — the great unwashed — may think of productivity as a measure of real output per hour of work — how much can be produce in so many man-hours of work — this is not at all how companies measure it. To put it simply, a company measures its productivity by the amount of profit it can produce with a given amount of wage.
Thus, in another article we find:
Of course, there’s the dark side to productivity. Efficient and flexible companies are more likely to shed employees quickly in response to a falloff in demand — real or expected — than they would have been in the 1970s and 1980s when they tended to hoard labor in hopes of an eventual recovery.
“Nowadays, (companies) seem to anticipate a decline in output and lay off workers ahead of time,” said Brookings Institution productivity expert Barry Bosworth.
That may keep productivity high, but with a far different human toll than output-driven productivity of the kind seen in the late 1990s when improvements in information technology led to entire new industries and employment opportunities. Employment grew then, just not as fast as output. The reverse is happening now: the economy is contracting, just not as fast as employment.
It is a common mistake to confuse these two different measures of productivity, but they are not the same and have no relation to each other. Since companies operate to maximize profits, they continually try to squeeze more output from the existing work force. In times of expansion, they hold the rate of growth of their work force to below the rate of growth of demand for their output; and, in times of contraction, they try to reduce the work force more rapidly than the demand for output contracts.
During a contraction, however, and under certain definite conditions, this impulse can lead to an economic death spiral as companies continually eviscerate their work force to shore up profits. When the demand from this work force is the most important source of demand for the goods produced, slashing the work force must result in the progressive collapse of demand for the output itself.
The evidence of this collapsing demand would be generally falling prices — the much dreaded deflation of the economy. Inflation slows, and then stops altogether and reverses, as falling prices invade one after another sector of the economy. Soon, the economy as a whole is engulfed in raging deflation as companies frantically slash the work forces ahead of the drop in demand created by the previous round of layoffs.
The deflation, of course, only signals that profit can no longer be the motive force for the production of goods. But, for capital this amounts to a death sentence, since the motive for capitalist activity is profit.
By the time quantitative easing becomes necessary this death spiral is already approaching like the Mother of All Storms on the horizon. Monetary and fiscal policy have already broken down, and things have truly progressed beyond the point when just any central bank can reverse the process. Policy tools have collapsed because the deflation threat is no longer a national problem but a global one for which there is no national solution.
If the deflation can be avoided, there is only one central bank capable of the scale of intervention necessary to prevent it. It is capable of intervening not because it is a national central bank, but because it already functions as the global central bank: The Federal Reserve, because it controls the world reserve currency, and can, as a consequence, impose inflation not just on the sheeple of the United States, but also on the populations of every country engaged in international trade.