UK steps in the right direction

Flattr this!

The UK Gov­ern­ment has tak­en the first ten­ta­tive steps towards a solu­tion to this cri­sis with its deci­sion today to give stressed bor­row­ers an inter­est repay­ment hol­i­day of up to two years (New scheme to help peo­ple at risk of repos­ses­sion).

The scheme is lim­it­ed in scope to house­holds that suf­fer “a sig­nif­i­cant and tem­po­rary loss of income as a result of the eco­nom­ic down­turn to defer a pro­por­tion of the inter­est pay­ments on their mort­gage for up to two years”. It also guar­an­tees banks that the deferred pay­ments will ulti­mate­ly be made.

This is a step in the right direction–towards ulti­mate­ly debt mora­to­ria. It isn’t enough–because the inter­est will still be compounded–but it does make the impor­tant point that the accru­al of inter­est on debt can be tam­pered with by leg­isla­tive means as well as by eco­nom­ic ones.

I favour the leg­isla­tive approach–which should ulti­mate­ly include debt mora­to­ria, or a revi­sion of this scheme which involves no accru­al of inter­est and repay­ments there­fore reduc­ing out­stand­ing principal–because I don’t believe the accept­ed eco­nom­ic approach­es to reduc­ing the real debt bur­den will work.

The stan­dard eco­nom­ic means to reduce the debt bur­den is to “print mon­ey to cause infla­tion”. Ben Bernanke him­self is famous for the fol­low­ing remark:

If we do fall into defla­tion, how­ev­er, we can take com­fort that the log­ic of the print­ing press exam­ple must assert itself, and suf­fi­cient injec­tions of mon­ey will ulti­mate­ly always reverse a defla­tion. (Bernanke, Defla­tion: Mak­ing Sure “It” Does­n’t Hap­pen Here)

I have lit­tle con­fi­dence in this mech­a­nism. It is pred­i­cat­ed on a Mon­e­tarist the­o­ry of mon­ey, in which, to quote the God­fa­ther, “Infla­tion is always and every­where a mon­e­tary phe­nom­e­non” (Mil­ton Fried­man, A Mon­e­tary His­to­ry of the Unit­ed States 1867–1960). It is pos­si­ble to sub­stan­tial­ly agree with this argu­ment and still argue that gov­ern­ment print­ing of mon­ey won’t cause inflation–because Mil­ton Fried­man’s “mod­el” of mon­ey com­plete­ly ignored the exis­tence of cred­it mon­ey.

Here is Mil­ton’s mod­el of mon­ey cre­ation and how that engen­ders infla­tion:

Let us sup­pose now that one day a heli­copter flies over this com­mu­ni­ty and drops an addi­tion­al $1,000 in bills from the sky, which is, of course, hasti­ly col­lect­ed by mem­bers of the com­mu­ni­ty. Let us sup­pose fur­ther that every­one is con­vinced that this is a unique event which will nev­er be repeat­ed…

… When the heli­copter starts drop­ping mon­ey in a steady stream … it takes time for peo­ple to catch on to what is hap­pen­ing…  As peo­ple catch on, prices must for a time rise even more rapid­ly, to undo an ini­tial increase in real bal­ances as well as to pro­duce a long-run decline… (Fried­man, “The Opti­mum Quan­ti­ty of Mon­ey”, in THE OPTIMUM QUANTITY OF MONEY AND OTHER ESSAYS, pages 4–5 and 13)

IF a heli­copter fly­ing over the land dis­pens­ing largesse  (oth­er­wise known as the Cen­tral Bank cre­at­ing M0) was the only man­ner in which mon­ey could be cre­at­ed, and IF there was no pri­vate debt, and IF the econ­o­my was in long run gen­er­al equi­lib­ri­um and prices pri­or to the heli­copter drop were there­fore equi­lib­ri­um prices… then this approach would work.

Yeah, right…

Instead, in the real world in which we live, finan­cial insti­tu­tions con­trol the cre­ation of mon­ey, pri­vate debt is at unprece­dent­ed lev­els, and the glob­al econ­o­my is rapid­ly tran­sit­ing from a far-from-equi­lib­ri­um debt-financed boom into a far-from-equi­lib­ri­um debt-induced crash in which the price of every­thing is total­ly out of whack.

In this world, gov­ern­ment cre­ation of M0 will be sent straight to the banks to reduce debt lev­els. The impact on turnover of goods and there­fore prices will be min­i­mal. Defla­tion will con­tin­ue, and could do so for years as the gov­ern­ment effec­tive­ly swaps base mon­ey for cred­it money–only to see the absolute mon­ey sup­ply drop. This was the Japan­ese expe­ri­ence.

Ulti­mate­ly, I expect that the fail­ure of the econ­o­my to respond to this Fried­man­ite ton­ic will result in a pro­found shift in pol­i­tics, in which the unthink­able today will become pol­i­cy: that much of the debt that the finan­cial sec­tor issued espe­cial­ly in the last two decades should nev­er have been cre­at­ed in the first place, and it should be abolished–in con­junc­tion with sub­stan­tial reforms to finan­cial assets that pre­vent a sim­i­lar debt-bub­ble in the future.

We are still a very long way from that change in con­scious­ness, but this move by the UK gov­ern­ment is a first step towards it.

Bookmark the permalink.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.