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Monetary Policy Distortions



April 05, 2012 – Comments (2)

Very good post by Michael Sankowski


Monetary Policy Distortions
April 5, 2012 By Michael Sankowski

Over at Naked Capitalism, there are two interesting posts up, and I’d like to point out an important link between them.

One is an interview with Jamie Galbraith “Finance as Wealth Transfer Mechanism” who says this:

“The act of extending credit – a macroeconomic force – generates fees and capital gains and other incomes that accrue, largely, to the top strata. You can see this very plainly in US data, but also in most other countries we’ve looked at, from Brazil to China. In sectoral data, it shows up in the fact that rising inequality is closely associated with relative gains by the financial sector.”

The other post is by…Dan Kervick. We said we will take good ideas from anywhere, and well, Dan has some great points in this post:

“People frequently rail against the pork barrel spending and earmarks that result from the legislative process. But the pork barrels don’t worry me nearly as much as handing our economy over to another generation of theory-addled elitists like Alan Greenspan. As part of the democratic process, representatives come from all over the country to look for the resources to deliver the things their constituents want and need. They wrangle and haggle. And yes, in the process they land a few “bridges to nowhere.” But most of what they get are bridges to somewhere. The people in New Hampshire might not like the way the people in Georgia use their share of our national resources, and the people in Georgia might feel the same way about the people in Oregon. But the end result is that things get built; people are hired; public goods are created; national and local needs are met; things get done.”


I’ve railed about the anti-democratic tradition running though economics over at Traders Crucible. Then I wrote about a long list of practical problems with Monetary Policy in this post. Turns out Jamie identified another major problem with using Monetary Policy – the high fees flow to one group of people.

Here is a full list of problems with monetary policy:

-- promotes debt slavery
-- works very slowly
-- ignores the lowest 30% of earners
-- anti-democratic look here.
-- difficult to manage
-- It must – must – end in a massive real estate bust – which destroys the primary store of value for the lower 80% of the population.
-- Difficult to observe effectiveness
-- Uses real estate lending as a transmission mechanism
-- Indirect instead of direct action
-- Promotes a rentier class
-- Promotes a massive banking system
-- Zero lower bound
-- Can’t be very effective in a real estate crash.
-- Promotes the military industrial complex to the exclusion of social welfare

Jamie Adds:

-- high fees
-- fees flow to rentier class (slightly different than Neil’s version)

This post is titled “Monetary Policy Distortions”. I created this list of suckage for Monetary Policy just to help people start thinking about the downside of Monetary Policy. But it also functions as a nice list of monetary policy economic distortions. 

Here is Brad Delong hoisting the flag for why monetary policy causes less distortions than fiscal policy:

“The principal argument for monetary policy is that, by modifying asset supplies and thus asset prices, it induces households and businesses to boost their spending on things that they almost bought anyway. Thus–for marginal policy shifts, starting out at a first-best optimum, and if the relative distribution of wealth corresponds to social welfare (or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)–monetary policy will not push you far away from the free-market optimum.

Fiscal policy, by contrast, works through expanded government purchases ΔG. These must be financed by distortionary taxes to amortize the debt in the future. These taxes do drive a wedge between the social and the private values of output in the future. And what the government buys is determined by a political rather than by an optimizing economic logic. [2]”

He’ll be here all week, folks! But more seriously, his caveat here is outrageous

“or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)”

I’ll translate to human readable language

“If you just ignore biggest ways Monetary Policy distorts every credit related transaction, it causes less distortion than Fiscal Policy. ”

It’s time for the economics profession to fess up on what it’s doing. It’s time to recognize Monetary Policy chooses winners and losers just like Fiscal Policy chooses winners and losers.

We need a way to move forward in the world. Ignoring the basic facts how Monetary Policy actually moves from central bank operations into the real world isn’t helping. And it also doesn’t help most of economics doesn’t even have room for the financial system in the model.

This is why it’s hard for economists to find the distortions, they don’t include the sectors where these distortions happen in the basic models of the economy.

In this case, I fully agree with Scott Fullwiler. Here is JKH on this idea:

“What is ground zero for language in economics?

Is it the language of economists and accountants or the language of the street or some language in between?

My own view is that there is a default ground zero language inherent in:

C + I + G + (X – M) = C + S + T

Furthermore, and here is where I’m totally with Scott Fullwiler, accounting logic is a necessary measurement infrastructure for all of economic thinking – at least the thinking that matters, which is coherent thinking.”

I’ll put out a hat tip to Clonal Antibody on this one too. He’s showed me a few eye-popping charts on what happened when usury laws were shifted from state to national control, which is another distortion of monetary policy on our real world economy.

2 Comments – Post Your Own

#1) On April 06, 2012 at 10:10 AM, outoffocus (23.89) wrote:

Great post.  I was actually having a very similar conversation yesterday (the day this blog was posted).  There is no need for the financial sector to be as large as it is.  Also, monetary policy does exactly what he says it does.  It does nothing for the people.  Its akin to "supply side economics", which oddly enough, seems to only work for the supply side. lol

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#2) On April 06, 2012 at 10:46 AM, binve (< 20) wrote:

Hey outoffocus,

I agree, good post. And completely agreed about the size of the financial sector, as I was saying here (and elsewhere):

Also, monetary policy does exactly what he says it does.  It does nothing for the people.

Exactly. What it does is manipulate cost channels by making 'money' more expensive. The affects both creditors and borrows, which means that it is *always* a blunt instrument. The fact that it cannot really target specific portions of the economy means that its is highly distortionary. 

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